By Robert Sanchez
August 27, 2022
Complying with sanctions imposed by the US Treasury’s Office of Foreign Asset Control (OFAC) requires closely monitoring its edicts. When individuals are added to the Specially Designated Nationals (SDN) List, or when entities are listed as sanctioned in sweeping executive orders, compliance teams are tasked with ensuring their new obligations are followed.
Names of individuals, shipping vessels, companies, addresses and organizations are publicly and clearly listed to mitigate confusion on what or who exactly is sanctioned. To help ensure the desired effects of halting the affairs between sanctioned parties and US entities, the 50% rule was devised.
Development of the 50% Rule
The rule originated in 2008 when OFAC provisions stated that an entity owned by 50 percent or more by a blocked person is itself blocked by law. This came when OFAC was enacting a larger effort of ensuring that the public’s sanctions compliance practices would no longer limit efforts of screening against the SDN List, nor against countries in which the US maintained sanctions programs. Such scrutiny would be necessary for conducting due diligence to investigate and unravel what is known as beneficial ownership, or the entity or person that enjoys the benefits of ownership even though the title to some form of property is in another name.
This push from OFAC in 2008 did expand requirements for additional due diligence by compliance programs but did not provide guidance on ownership by multiple blocked parties. At that time, compliance programs could allow interaction with an entity if it was determined that no single blocked person owned 50 percent or more of an entity. This principle of multiple sanctioned beneficial owners of entities would be a driving force in formally codifying a 50% rule.
Aggregated ownership became a primary goal for the 50% rule, which was formally announced in 2014. Primarily, the rule states that “any entity owned in the aggregate, directly or indirectly, 50 percent or more by one or more blocked persons is itself considered to be blocked.” The rule has since applied to every instance of sanctions actions and programs.
Provisions and Examples
There are multiple ways in which the 50% rule can be applied. To start, let’s consider the following example of beneficial ownership.
- Sanctioned Person X owns 50 percent of Company A, and Company A owns 50 percent of Company B. Company B would be considered sanctioned in this case, due to Sanctioned Person X owning indirectly 50% of Company B. In addition, Sanctioned Person X’s 50 percent ownership of Company A makes Company A a sanctioned entity. Company A’s 50 percent ownership of Company B also makes Company B a sanctioned entity.
The same concept applies in the aggregate when a total of 50 percent applies to beneficial ownership via multiple corporations.
- Sanctioned Person X owns 50 percent of Company A and 50 percent of Company B. Companies A and B each own 25 percent of Company C. Company C is considered to be sanctioned in this case. This is so because, through its 50 percent ownership of Company A, Sanctioned Person X is considered to indirectly own 25 percent of Company C, and through its 50 percent ownership of Company B, Sanctioned Person X is considered to indirectly own another 25 percent of Company C. When Sanctioned Person X’s indirect ownership of Company C through Company A and Company B is combined, it equals 50 percent. Company C is also considered to be sanctioned due to the 50 percent aggregate ownership by Companies A and B, which are themselves sanctioned due to Sanctioned Person X’s 50 percent ownership of each.
In some cases, a combination of beneficial ownership by a sanctioned person and a sanctioned entity’s partial ownership can cause a company to be sanctioned.
- Sanctioned Person X owns 50 percent of Company A and 10 percent of Company B. Company A also owns 40 percent of Company B. Company B is considered to be sanctioned. This is so because, through its 50 percent ownership of Company A, Blocked Person X is considered to indirectly own 40 percent of Company B. When added to Sanctioned Person X’s direct 10 percent ownership of Company B, Sanctioned Person X’s total ownership (direct and indirect) of Company B is 50 percent. Company B is also blocked due to the 50 percent aggregate ownership by Sanctioned Person X and Company A, which are themselves both sanctioned persons.
It is important to remember that the rule is dependent on its percentage threshold, and will not necessarily be enforced just due to the presence of beneficial ownership by sanctioned persons for parent companies. The following example highlights how 50 percent beneficial ownership is constantly required.
- Sanctioned Person X owns 50 percent of Company A and 25 percent of Company B. Companies A and B each own 25 percent of Company C. Company C is not considered to be sanctioned. This is so because, even though Sanctioned Person X is considered to indirectly own 25 percent of Company C through its 50 percent ownership of Company A, Company B is not 50 percent or more owned by Sanctioned Person X, and therefore Sanctioned Person X is not considered to indirectly own any of Company C through its part ownership of Company B. Sanctioned Person X’s total ownership, direct and indirect, of Company C, therefore, does not equal or exceed 50 percent. Company A is itself a sanctioned person, but its ownership of Company C also does not equal or exceed 50 percent.
Challenges Facing the Compliance Community
Alexandra Solórzano is an investigative consultant with Owl Consultancy Group and has extensive experience with sanctions compliance practices. When asked about obstacles regulatory professionals face when determining ownership by blocked persons for entities, Ms Solórzano said: “At face value, the 50% rule seems simple to understand. However, the part that not many people think about is control. An entity may not be owned by an SDN, but it can definitely be controlled by an SDN. Another challenge is determining ‘shadow’ SDNs.”
Shadow SDNs in this case connote entities sanctioned through the application of the 50% rule but are not explicitly sanctioned by an OFAC announcement or listing.
Ms Solórzano continued: “OFAC tries to designate as many SDN subsidiaries as it can, but it’s not always successful. Compliance professionals should always conduct an ultimate beneficial ownership (UBO) screening to ensure the entity in question is not a shadow SDN. Complex ownership chains can make this determination extremely hard, but it’s always best to take the time to obtain as much information as possible rather than to engage in a violation.”
Ms Solórzano went on to highlight common strategies used by sanctioned entities or persons to avoid enforcement of the 50% rule. “The rule can be easily evaded by criminals by lowering their ownership threshold and using fronts. In other words, an entity can be owned 48% by an SDN and 52% by a non-sanctioned person.
“However, if the said entity is controlled by the SDN, meaning the SDN has signatory power and decision-making authority, it is controlled by the SDN and that entity is acting as an agent of the SDN and could become sanctioned in the near future. Even if the entity does not become sanctioned, it is still acting in the interest of the SDN and should be avoided or treated with extreme caution and scrutiny. Also, one must look closely at the entity owning 52% to ensure it’s not an associate of the SDN engaging in a sanctions evasion tactic.”
Ms Solórzano said sanctions evasion techniques are becoming more sophisticated. “Illicit actors are using close associates to act on their behalf as well as using layering techniques by using fronts and shell companies that become dead ends when they are registered in secrecy jurisdictions. Thus, being able to conduct deeper and thorough enhanced due diligence should become the norm and standard across the industry.”
Ms Solórzano shared what she perceives to be the most significant challenge to enforcing the 50% rule: “[In regard to] compliance professionals, it comes down to time, expertise, and secrecy jurisdictions.
- In regards to time, a well-done sanctions evasion technique can take up considerable time to be able to uncover, when time is of the essence, compliance professionals are only able to scratch the surface, and can miss a whole scheme due to the time crunch involved.
- In terms of expertise, not many people have the language capabilities and cultural understanding to be able to look at local sources and make the necessary connections to identify known associates and activities that are being used to divert one’s focus away from the SDN.
- Finally, there are secrecy jurisdictiions [which are jurisdictions that provide facilities that enable people or entities to escape or undermine the laws, rules and regulations of other jurisdictions elsewhere, using secrecy as a prime tool]. These are the hardest to be able to obtain the information needed and the favorite choice of most criminals. When [information] is safely guarded, the trail hits a dead end. In such instances, a compliance professional or investigator must evaluate the data gathered and determine if there’s enough to build up a case of enough suspicion to accuse the entity in question of being owned or controlled by an SDN or if there’s nothing there.”
Compliance professionals must understand that entities can be subject to the 50% rule and not initially be announced by OFAC along with a new sanctioning action. These ‘shadow SDNs’ can cause a liability for entities down the road. Compliance teams must exercise vigilance, due diligence and vet the beneficial owners of the entities their companies interact with.
As noted in the examples, the 50 percent rule can be applied in several ways, and therefore it is vital to determine the status of all beneficial owners of an entity, over multiple ‘generations’ of ownership.
To counter the efforts of sanctioned entities to get around the 50 percent rule, explore all practical possibilities. Sanctioned persons will apply savvy techniques to obfuscate ownership, employ layers of front-persons and shell entities, and exploit gaps in jurisdictional enforcement. Be hyper-vigilant and constantly look into how entities they interact with could potentially be serving sanctioned parties.