by Dr. Carlo Gallo, Enquirisk
Investigative services play a key role in enabling sound and compliant international business. Despite economic and geopolitical headwinds, international business is still big business. Over 80 percent of the world’s GDP is produced outside of the United States (US) and, in 2022, the US exported more than $2 trillion worth of goods and $930 billion of services.
International business often involves dealing with very opaque jurisdictions. In those cases, the real beneficiaries of local business entities are often hidden. They may include corrupt state officials, defense-sector entities, US-sanctioned entities, or even organized criminal groups. Moreover, foreign counterparties may rely, directly or indirectly, on illegal or unethical labor or environmental practices.
As part of legal compliance programs, fraud detection and brand protection, US companies must run scrupulous checks on the foreign entities they want to acquire, form joint-ventures with, onboard customers, or engage as suppliers and distributors. Certain lines of business, industries, locations or types of third-party relationships will be associated with higher risks. In those situations, investigative skills are required to perform the necessary enhanced due diligence.
At the same time, as US regulators expect companies to exercise more scrutiny over foreign third-parties, doing so is becoming more difficult due to the rise of authoritarianism globally. Autocratic regimes are tightening up control over the information space, making investigative reporting more difficult. Journalists are increasingly targeted by police persecution or even extra-judicial violence. Moreover, sharpening geopolitical competition can place US businesses abroad in the crosshairs of local governments.
As private investigative services become more important due to growing regulatory requirements, they also face rising challenges in many opaque and repressive jurisdictions.
A Growing Regulatory Burden
The US and G7 sanctions enacted in response to Russia’s invasion of Ukraine in February 2022 are some of the most extensive issues. They banned businesses from dealing with hundreds of Russian individuals and entities in specific economic sectors, and with specifically designated administrative and political organizations, and functionaries. They also blocked the assets of designated persons, banned the supply of Western dual-use technologies, and mandated price caps on Russian crude oil and oil products. The US government is enforcing such sanctions very robustly.
More generally, the US Office of Foreign Assets Control (OFAC) manages over 35 sanctions programs. Targets range from whole countries or regions (Cuba, Iran, North Korea, Syria, and the Crimea region of Ukraine), to foreign governments (Venezuela, Nicaragua); and from specific economic sectors, to particular individuals and entities. All in all, OFAC has targeted well over 9,000 individuals and entities worldwide. Importantly, sanctioned individuals may reside in countries that are not sanctioned.
Besides OFAC, several other US government agencies also administer their own restrictions on international trade. For example, one prominent area of growing regulation is the control of technology exports to China. Regarding export controls, it is important to note that, if a US company employs a foreign national, within US territory or outside, sharing technology with them is also a “deemed export”.
Other laws require companies to proactively check that their direct and indirect suppliers do not engage in child labor or forced labor, are not violating environmental standards, are not sourcing inputs from sanctioned countries or entities, etc. Moreover, under the US Foreign Corrupt Practices Act (FCPA) and similar legislation from other countries, companies must ensure that their agents, intermediaries and contractors are not paying bribes on their behalf anywhere in the world.
Finally, financial institutions must perform in-depth screening of customers hailing from jurisdictions considered “high-risk” from the Anti-Money Laundering and Counter-Terrorism Finance perspective. They must keep monitoring the risk profile of high-risk customers, including their reputation in foreign language media.
Compliance with all of these laws often requires insights into third parties that cannot be achieved with automated screening or superficial desktop research. For situations of heightened risk, an investigative approach is needed.
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The Need for Investigations
While legal advice is essential to ensure compliance with such a plethora of legal requirements, investigators are often needed too. Concerning US sanctions, two aspects, in particular, underline the need for in-depth due diligence:
• 50 percent ownership rule: sanctions apply not only to designated individuals and entities but also to any entity they own 50 percent or more of, individually or jointly. Companies must find out whether a company they are dealing with meets these ownership criteria—there is no official list of such entities. Automated screening and public records are unlikely to help, as ownership is often hidden behind complex ownership structures that may involve shell companies registered in low-transparency jurisdictions.
• Foreign direct product rule: It allows the US Department of Commerce’s Bureau of Industry and Security (BIS) to restrict the export of controlled technologies (components, software, etc.) to customers anywhere in the world that use them to build products sold on to sanctioned entities, countries or sectors. Therefore, companies selling relevant goods and services need to be reassured about their customers’ customers.
Investigators can also help businesses audit their supply chains to ensure they are free from illegal or unscrupulous activities, such as bribery and fraud. Investigators can support international litigation with asset tracing and perform enhanced due diligence for Anti-Money Laundering purposes.
Finally, investigators are key to pre-transaction due diligence: A US company that seeks to acquire a foreign entity must investigate the legal, integrity and reputational risks associated with the target’s geographical footprint of sales and operations. It is necessary to conduct due diligence not only on the acquisition target, but also on the company’s third-party relationships.
Conducting Investigations in Challenging Environments
Enhanced due diligence is all the more necessary when the client is dealing with counterparties in opaque, repressive and generally “high-risk” jurisdictions. In those cases, the first rule should be to avoid breaking local laws. Typically, investigative methods that are illegal in the US tend to be illegal anywhere else, too: eavesdropping, hacking, breaking and entering, stealing information, etc. Unfortunately, from time to time, media scandals bring to light allegations that leading due diligence firms have resorted to such methods, typically in emerging markets.
The second rule should be to ensure the safety of local collaborators. Running confidential inquiries on the ground is becoming more difficult in authoritarian jurisdictions that tighten control over the information space. For example, some governments are expanding and blurring the definition of “national security” in ways that could criminalize the sharing of due diligence information—for example, on the track record, associations and reputation of local business players—unrelated to state secrets. Authoritarian governments also restrict foreign access to previously public databases, such as corporate registers.
From time to time, foreign governments may implement anti-Western campaigns that can lead to intimidation tactics against Western companies, including due diligence firms. This may include police raids on company offices, interrogating personnel, slapping heavy fines, detaining and charging business managers, etc. Moreover, the targets of due diligence investigations often are very wealthy and well-connected individuals who can trigger police investigations on an intelligence firm in retaliation for a ‘frank’ report.
Such challenging conditions place a premium on PIs with true regional and country expertise and know-how to extract relevant information from a shrinking pool of sources. While there are no “magic” databases in many emerging markets that will provide easy answers, expert eyes can detect interesting patterns and infer useful conclusions from available information. In the first instance, a lot can be achieved without setting foot in high-risk countries.
Other considerations to bear in mind include the fact that documentary evidence may not be obtainable in business environments where informality is widespread and business agreements are reached verbally—as opposed to being written down. Furthermore, national governments may be involved in business life in multiple ways that go well beyond formal state ownership of stakes in a given company. Finding out about this requires careful analysis by investigators who can look at local parties through the lenses of their local knowledge and experience.
Powerful and politically-connected players often run companies through proxies and nominees to conceal their involvement. The real owners may often be corrupt state officials. Knowing who the Ultimate Beneficiary Owner of a company is will not help if that person is only fronting for somebody else. Similarly, finding out the names of the company principals will not be enough. One must also look into track records and associations to detect “red flags.”
In summary, legal compliance and risk management for opaque and repressive jurisdictions require patient, clever investigative work that leverages language skills and deep knowledge of the operating environment. Much can be deduced by critically examining open-source, legally available documents and registry items. If it is necessary to run on-the-ground human source inquiries, relying on tried and tested local collaborators who are seasoned and cautious professionals is essential. An international network of trusted local sources makes all the difference and cannot be improvised.
About the Author
Dr. Carlo Gallo is the Director of Enquirisk. He has 17 years of experience helping multinationals navigate complex business environments. Before founding Enquirisk in 2012 (initially in London, UK), he was Control Risks’ lead Russia/FSU analyst. He holds a Ph.D. from the LSE and has been a reputable business risk commentator on various programs. Previously, he completed a Masters and PhD at the London School of Economics (LSE). Born and raised in Italy, Dr. Gallo spent 20 years in London before moving to Santa Monica, California. Enquirisk operates under California PI license (n.189080).