Impact of sanctions regimes on audit and compliance responsibilities

February 2023 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

The last few months, or even years, have been a real challenge for the global economy. The world seemed to be slowly recovering from the shock that the global coronavirus (COVID-19) pandemic caused, affecting the functioning of almost everyone around the world and throwing up new challenges for enterprises that had to adapt their activities to new realities day to day. Then came another shockwave: Russia’s aggression against Ukraine.

Almost all the states which opposed this aggression decided to respond and express their disagreement by taking decisive steps. The response led to a legislative avalanche which spilled over into relations with Russia and forced companies conducting business internationally to be particularly vigilant in order to ensure compliance. The examples of European Union (EU) legislation, as well as legislation in Poland – as an EU member state – and that of Ukraine and Russia, are enough to demonstrate the challenges faced by audit and compliance units.

EU sanction rounds

The economic sanctions imposed on Russia by the EU are nothing new. Legal acts forming the basis for adopting the first round of economic sanctions against Russia were adopted in 2014 as a result of the annexation of the Crimean Peninsula by Russia. Those acts are: (i) Council Regulation (EU) No 269/2014 of 17 March 2014 concerning restrictive measures in respect of actions undermining or threatening the territorial integrity, sovereignty and independence of Ukraine; and (ii) Council Regulation (EU) No 833/2014 of 31 July 2014 concerning restrictive measures in view of Russia’s actions destabilising the situation in Ukraine. Each subsequent package of sanctions is an amendment to the aforementioned acts.

Sanctions introduced under the EU sanctions package are of two types: targeted restrictive measures against certain persons (individual sanctions) and economic sanctions. The individual sanctions target natural or legal persons who – as stated in Regulation (EU) No 269/2014 – “are responsible for actions which undermine or threaten the territorial integrity, sovereignty and independence of Ukraine, including actions on the future status of any part of the territory which are contrary to the Ukrainian Constitution, and natural or legal persons, entities or bodies associated with them”. Placing a person on the sanction list entails consequences of immense significance, i.e., preventing them from entering or transiting through EU territory, by either land, air or sea (travel ban) and freezing all accounts belonging to them in EU banks. It is also prohibited to make any funds or assets directly or indirectly available to them. In practice, this means a ban on any cooperation with them.

Economic sanctions are of a slightly different nature. They aim to effectively thwart Russia’s ability to continue its aggression. As part of the economic sanctions, the EU has imposed a number of import and export restrictions on Russia. This means that European entities cannot sell certain products to Russia (export restrictions) and that Russian entities are not allowed to sell certain products to the EU (import restrictions).

The EU has prohibited Russian road transport operators from entering the EU, including for goods in transit. Recently, the eighth round of sanctions has extended this prohibition to the direct or indirect provision of architectural and engineering services, IT consultancy services and legal advisory services to the Russian government or to legal persons, entities or bodies established in Russia. These are just some examples of sanctions which illustrate how EU regulations affect the sphere of doing business with Russian entities.

The tip of the legislative iceberg

Polish perspective. EU regulations are just a prelude to the legislative activity resulting in adoption of legal acts that enterprises operating within the EU have to take into account in their operations. Some countries have also individually and within the framework of their own legislation decided to address the situation and condemn Russia’s aggression. For example, Poland passed the Act of 13 April 2022 on special measures to prevent support for aggression against Ukraine and to protect national security.

This sanctions law introduces the so-called ‘Polish sanction list’ – a national sanction list, maintained by the minister of internal affairs and administration, establishing a list of persons and entities against whom the sanction measures specified in the law apply. The measures in question are primarily those set forth in article 2(1)-(3) of EU Regulation 765/2006 or articles 2 and 9 of EU Regulation 269/2014 (with certain exemptions), in particular: (i) freezing of funds and economic resources owned, held, effectively possessed or controlled by the listed persons and entities; and (ii) the prohibition of making available, directly or indirectly, any funds or economic resources to listed persons and entities. To this catalogue, Poland’s sanctions law adds a further measure in the form of exclusion from public procurement procedures, and a measure in the form of inclusion in the list of foreigners whose stay in the territory of the Republic of Poland is undesirable.

The Polish law is thus an extension of EU sanctions of an individual nature. However, noteworthy in this regard are the far-reaching possibilities of the Polish state against an entity that is included on the Polish sanction list. These were introduced into the legal order on the basis of the amendment to the sanctions law which came into force on 18 August 2022 and provides for the possibility of temporary administration being established for such an entity. This may be established if it is necessary to ensure the functioning of an enterprise operating in the territory of the Republic of Poland, to maintain jobs in this enterprise or to maintain within the scope of activity of this enterprise the provision of public services or the performance of other tasks of a public nature, and where it is necessary to protect the economic interest of the state. This does not exhaust the possibilities of the state. The amendment also provides for the possibility to establish temporary administration in order to take ownership of financial resources, funds or economic resources belonging to a person or entity included on the sanction list by the state treasury, if this is necessary to protect an important public interest or an economic interest of the state, or to ensure state security.

Brief overview of measures taken by Ukraine. Needless to say, all sanctions adopted by the EU or its member states and aimed at reducing Russia’s economic potential are supported by Ukraine, which at the same time is taking its own measures in this regard. As a result, apart from martial law, which has been in effect in Ukraine since 24 February 2022, other special legal acts have been adopted in various fields, including those directly affecting business activity.

On the one hand, these are individual sanctions, for instance the recently adopted: (i) Decision of the National Security and Defense Council dated 19 October 2022 ‘On Amending and Imposing Personal Special Economic and other Restrictive Measures (Sanctions)’, approved by Presidential Decree No. 726/2022 (19 October 2022) and; (ii) the Decision of the National Security and Defence Council (19 October 2022) ‘On Amending and Imposing Personal Special Economic and other Restrictive Measures (Sanctions)’, approved by Presidential Decree No. 727/2022 dated 19 October 2022.

At the same time, some attempts are being made at the legislative level to discourage enterprises from doing business in Russia, the best example of which is the amendment to the pharmaceutical law on cancelling marketing authorisations due to ties with Russian or Belarusian pharmaceutical manufacturing (Law No. 2271-IX, 22 May 2022).

Countermeasures taken by the Russian Federation in terms of reciprocity. The above actions reflecting a coordinated response to the Russian aggression have not remained without further response from the authorities of the Russian Federation, which extended the war on the military front against Russia into a kind of economic dispute with the so-called ‘unfriendly states’. Russia has thus adopted a whole range of legislation, and just as a small illustration and example, the following acts may be pointed out here: the Decree of the President of the Russian Federation (28 February 2022) ‘On the application of special economic measures in connection with the unfriendly actions of the United States of America and Foreign States and International Organisations that have joined them’ that introduces restrictions on foreign exchange transactions; specific decrees providing for export bans or – also recently adopted – decrees imposing restrictions on transactions in stocks and shares (Decree No. 737 (15 October 2022), ‘On Certain Issues of Carrying out (Execution) of Certain Types of Transactions (Operations)’.

Impact of sanctions regimes on audit and compliance responsibilities. Increased sanctions activity by state regulators has suddenly placed us in a reality where companies conducting business internationally can be affected by legislation passed in different jurisdictions, and in which due diligence in investigating whether a transaction can be performed, or whether it can be performed with a given person, is crucial. For this reason, companies should form (if they have not already done so) and apply in their everyday operations best trade compliance practices.

These consist primarily of verifying the admissibility of a given transaction, and verifying the contractor. While verifying the admissibility of a transaction seems straightforward, because it can be done simply based on legal provisions, verifying the counterparty is more complex. So, how to proceed? This is a question that certainly more than one audit and compliance department is asking. A clear and specific answer on how to conduct verification is not easy. There are, however, some guidelines, outlined below, that should be followed.

First, a superficial check of the contractor may not be sufficient. The sanctions regime requires “deeper acquaintance” with the contractor: who is behind the company, what is the ownership structure and who are the real beneficiaries?

Second, not only should a direct contractor be subject to verification, but other persons related to the transaction, such as the final recipient, should also be verified.

Third, verification should be done in real time (before conclusion of the contract, shipment of goods and transfer or receipt of funds).

Finally, verification cannot be random. Continuous monitoring is essential.

The above will not ensure success if audit and compliance departments are not properly trained and able to identify risks in time.

One thing is certain: over the coming months we will have to operate under a sanctions regime that is dynamic, and following it will be crucial. Companies’ approaches should therefore be comprehensive and ensure compliance using various systematic tools.

Agnieszka Deeg-Tyburska is general counsel and Edyta Rybińska-Burger is a legal adviser at Polpharma. Ms Deeg-Tyburska can be contacted by email: agnieszka.deeg@polpharma.com. Ms Rybińska-Burger can be contacted by email: edyta.rybinska@polpharma.com.

Agnieszka Deeg-Tyburska and Edyta Rybińska-Burger

Polpharma