New US Government Advisory Raises the Bar for Sanctions Compliance in relation to Ship Owners and Their Insurers

May 22, 2020
By: Saskia Rietbroek, CSS, Executive Director, ACSS

With millions of dollars in potential fines in the balance, on May 15, 2020, the U.S. government released new guidance and compliance expectations for those involved in the maritime industry, energy, and metals sectors.

The 35-page Sanctions Advisory for the Maritime Industry, Energy and Metals Sector, and Related Communities (“Sanctions Advisory”), jointly published by the Department of State, Department of Treasury’s Office of Foreign Assets Control (OFAC), and the U.S. Coast Guard, provides measures and tools to counter risks related to illicit shipping and sanctions evasion. The Sanctions Advisory mainly relates to those sanctions programs imposed against Iran, North Korea, and Syria.

For years, the enforcement focus has leaned towards the financial sector, but a recent rush of enforcement and strategic designations, such as Chinese shipping giant COSCO-Dalian, has brought anxiety to corporate boardrooms in the maritime industry, leading to large fines and settlements paid to the government.

While not legally binding, this new sanctions Advisory seeks to assist companies in the maritime industry, energy and metal sectors to comply with the sanctions laws and regulations in good faith.

Industries Affected

The Sanctions Advisory suggests that specific sanctions risk mitigation measures should be adopted or considered by the following industries:

• maritime insurance companies;
• flag registry managers;
• port state control authorities;
• shipping industry associations;
• financial institutions;
• ship owners, operators, and charterers;
• classification societies;
• vessel captains;
• crewing companies;
• regional and global commodity trading, supplier, and brokering companies; and
• companies in supply chains of trade in the energy and metals sectors, including trade in crude oil, refined petroleum, petrochemicals, steel, iron, aluminum, copper, sand and coal.

It emphasizes that businesses in these sectors should appropriately assess their sanctions risks, and as necessary, implement compliance controls to address gaps in their compliance programs.

Tips to Avoid Bad Actors

The Sanctions Advisory warns the maritime shipping sector to watch out for novel tactics used by sanctions evaders as well as illicit maritime trade linked to Iran, Syria and North Korea, and cargoes.

“It’s easy to overlook the techniques used to evade sanctions in the shipping industry unless you’re an actual logistics company,” says Scott Nance, Principal at Langley Compliance Consulting LLC. “Shipping is an integral part of the supply chain, though, and sanctions evasion in shipping affects exporters, importers, and banks as well as the shippers themselves,” he reminds us.

The evasive tactics identified in the Sanctions Advisory are:

1. Disabling or Manipulating AIS on Vessels: The disabling or manipulation of AIS, an internationally mandated system that transmits a vessel’s identification and position via radio waves. Industry actors are cautioned by the Sanctions Advisory to be vigilant about engaging with parties or vessels with a history of disabling or manipulating AIS.
2. Physically Altering Vessel Identification: The Sanctions Advisory warns that vessels involved in illicit activities often paint over vessel names and unique International Maritime Organization (IMO)7-digit numbers to pass themselves off as different vessels.
3. Falsifying Cargo and Vessel Documents: The Sanctions Advisory informs us that authorities have found sanction evaders falsifying shipping documentation pertaining to petrochemicals, petroleum, petroleum products, or metals (steel, iron) or sand to disguise their origin. Persons conducting transportation or trade are advised to conduct due diligence on documents that indicate or suggest that cargo is from an area they determine to be high risk for sanctions evasion, notwithstanding any purported low risk place of origin.
4. Ship-to-Ship Transfers: The Sanctions Advisory points out that transfers of cargo between ships at sea “especially at night or in areas determined to be high-risk for sanctions evasion or other illicit activity” are often used to disguise cargo origin or evade sanctions.
5. Voyage Irregularities: The Sanctions Advisory recognizes that transit and transshipment are common in the global movement of goods, but encourages those operating in the industry to “scrutinize routes and destinations that deviate from normal business practices.”
6. False Flag and Flag Hopping: The Sanctions Advisory recommends that the private sector be aware of and report to competent authorities instances of falsifications of flags or flag hopping.
7. Complex Ownership or Management: Because complex business ownership and management structures may hide ultimate beneficial owners of cargo and commodities, those in the industry are warned by the Sanctions Advisory to be vigilant. If private sector entities are unable to reasonably identify the real interested parties of a transaction, they may wish to consider performing additional due diligence to ensure it is not sanctionable or illicit.

‘Institutionalize’ Your Sanctions Compliance Program Through Risk Assessment

The Sanctions Advisory contains recommended measures to detect red flags and other anomalies that may indicate the above illicit or sanctionable behavior. A key measure recommended by the Sanctions Advisory is the “institutionalization” of a sanctions compliance program.

In line with the risk-based approach delineated in “A Framework for OFAC Compliance Commitments” published in May 2019, the institutionalization of a sanctions compliance program starts with an assessment of your company’s sanctions risk. You will have to assess a variety of factors—including: the company’s size and sophistication, products and services, customers and counterparties, and geographic location, as well as assign a risk score to each.

The risk assessment is an essential step in your effort to take “measures consistent with your risk assessment”, a phrase mentioned several times in the Sanctions Advisory. The risk assessment will indicate where your company’s vulnerability to potential sanctions risk is the highest. After this first step, you can take a risk-based approach in your measures.

Robert Walsh, Deputy Chief Compliance Officer and Global Financial Crime Officer of AXA Group says: “The emphasis on a risk-based approach is sensible and demonstrates that the authorities are making an effort for this to be workable for companies. Mr Walsh warns us, however, that “these expectations definitely raise the bar” and that “this is an area of intrinsic complexity.” He continues by recommending that, “Compliance officers will need to be thoughtful and work closely with their advisors and operational departments to get this right.”

Other pillars of an institutionalized sanctions compliance program as offered by the Sanctions Advisory are:

• implementing a compliance and due diligence program;
• training to personnel; and
• communication of compliance expectations to counterparties, affiliates, and partners.

Tracking the Manipulators

A common theme in this Sanctions Advisory (and previous government advisories) is the mitigation of risk caused by AIS manipulation.

Vessels can turn off their tracking system when carrying out illicit acts, however those acts create a trail of their own. The Sanctions Advisory cautions compliance professionals to be vigilant when engaging with parties or vessels with a history of disabling or manipulating AIS. The Sanctions Advisory further recommends establishing AIS best practices and contractual requirements where necessary.

A number of different software tools can be used to detect this kind of behavior. These software tools employ algorithms to ensure those manipulating AIS are tracked and prevented from illicit activity.

According to Dave Loeser, Senior Director of Product Strategy – Financial Crime Screening at Accuity: “More than ever, meeting regulatory expectations for international trade activities requires technology and data. The red flags and best practices emphasized in the Advisory clearly call for widespread adoption of technology and data for all participants in the maritime sector, ranging from flag registries to insurers. Not only must all aspects of an international trade be subject to comprehensive sanctions screening against enhanced datasets, but needs to be monitored throughout its life cycle to identify additional risks and red flags.”

Best Practices for Monitoring and Due Diligence

The Sanctions Advisory also recommends monitoring ships throughout the entire transaction life cycle, consistent with an institution’s sanctions risk assessment.

With regard to knowing Your Customer and Counterparty, the Sanctions Advisory explains that this includes: maintaining names, passport ID numbers, as well as copies of photo ID of each customer’s beneficial owner. For example, if a legal entity is seeking to register a vessel, with the alleged intention being to insure or finance that vessel, each of the parties should (1) request documents regarding the beneficial owner/owners of the vessel, and (2) seek to verify this information with the documentation mentioned above, as appropriate and on a risk-basis.

Another key element is exercising supply chain due diligence. The Sanctions Advisory says the exporters and entities across the maritime supply chain are encouraged to conduct appropriate due diligence to ensure that a transaction does not involve commodities that may trigger sanctions, such as Iranian petroleum or North Korean coal.

Companies are encouraged to review the details of the underlying voyage including the vessel, cargo, origin, and destination, in line with their internal risk assessment. Companies are also encouraged to review the relevant documents in order to demonstrate that the underlying goods were delivered to the port listed in the documentation and not diverted a part of a sanctions evading scheme.

Add to Your Contractual Language

Members of the industry are encouraged to incorporate their best practices in contracts related to the their commercial trade, financial and other business relationships in the maritime industry.

Share Industry Information

The Sanctions Advisory recommends that industry groups encourage members to provide relevant information and share it broadly with partners, other members and colleagues consistent with applicable laws and regulations. Similarly, vessel owners are encouraged to share information with their banks, potentially working through competent authorities where required.

Industry-Specific Due Diligence Measures

The Sanctions Advisory substantially expands on previous shipping advisories that OFAC and other agencies have issued in the past. In particular, the Sanctions Advisory provides 14 pages of industry-specific suggested due diligence practices for the mitigation of sanctions risk.

The suggested measures vary per industry. Here are a few examples:

For marine insurers: 10 measures, which include:

• Incorporating contractual language and explicitly notifying clients that AIS disablement or manipulation inconsistent with SOLAS is possible grounds for investigation by the insurer of the ship’s activities and could result in cancellation of insurance.
• Informing legal regulators/competent authorities, other insurers, commercial databases, the International Maritime Organization (IMO), and when relevant, the United Nations (UN) Security Council 1718 Committee Panel of Experts (the UN DPRK Panel of Experts) in the event of insurance denial or cancellation of services of a vessel in relation to illicit activity.

For flag registry managers: 21 measures, which include:

• adopting a system of QR codes or barcoding of documents in order to easily check for authenticity, validity, or cancellation of registry documents using a mobile phone app or by accessing the website of the former Flag State. (for flag registry managers)
• Organizing trainings and seminars on UN and U.S. sanctions implications for the owners and managers of vessels they have flagged that could potentially be facilitating sanctionable or illicit activities.

For port state control authorities: 9 measures, which include:

• Requiring vessels arriving in port to maintain AIS broadcasts, as provided for in SOLAS.
• Reviewing bills of lading to confirm origin of the cargo. Bills alleging oil, petrochemicals, fuel, and metals from areas determined to be high-risk for sanctions evasion should be reviewed with particular due diligence.

For shipping industry associations: 2 measures, which include:

• Disseminating this Sanctions Advisory, or creating their own Sanctions Advisory addressing these issues, and providing it to members in order to raise awareness of global deceptive shipping practices and identify the ways that members can mitigate the risks of involvement in illicit shipping activities.
• Providing regular case studies and updates regarding illicit activity in industry-wide circulars, particularly in relation to shipping oil and petroleum products.

For commodity traders, supplier and brokering companies: 14 measures, which include:

• Ensuring employees who reveal illegal or sanctionable behavior are protected from retaliation, and ensuring there is a confidential mechanism to report suspected or actual violations of law or sanctionable conduct.
• Sensitizing clients to potential sanctions risk related to activities involving Iranian, North Korean, or Syrian ports.

For financial institutions: 4 measures, which include:

• Assessing client activity for transactions inconsistent with the client’s typical business practices, to include when clients acquire new vessels.
• Assessing client acquisition or sale of vessels to determine that the client’s assets do not include blocked property.

Ship owners, operators and charterers: 15 measures, which include:

• Identifying the vessels which, in the past two years, have a pattern of AIS manipulation not consistent with SOLAS and terminate business relationships with clients that continue to use those vessels.
• Keeping and analyzing records, including, where possible, photographs, of delivery and recipient vessels and/or recipients located at ports when possible, to enhance end-use verification

For classification societies: 11 measures, which include:

• Keeping records, including photographs, of recipient vessels and/or recipients located at ports when possible, to enhance end use verification.
• Adopting Know Your Customer (KYC) due diligence measures to the extent appropriate.

For captains: 7 measures, which include:

• Understanding, and ensuring your deck officers are aware of, the IMO required AIS regulations, which include consistently broadcasting AIS transmissions consistent with SOLAS.
• Circulating information about an award offered through the Rewards for Justice (RFJ) program that offers rewards of up to $5 million for information that leads to the disruption of financial mechanisms of persons engaged in certain activities that support North Korea, including illicit shipping activities, money laundering, sanctions evasion, cyber-crime, or weapons of mass destruction (WMD) proliferation.

For crewing companies: 6 measures, which include:

• Being aware of, and ensuring your crewmembers are aware of, the IMO circulated Sanctions Advisory in relation to illicit shipping and why these practices are unsafe.
• Ensuring employees who reveal illegal or sanctionable behavior are protected from retaliation, and ensuring there is a confidential mechanism to report suspected or actual violations of law or sanctionable conduct.

Compliance Implications for U.S. and Foreign Companies

The Sanctions Advisory has potential compliance implications for not only U.S. persons involved in the international trade and movement of cargo, but also foreign persons. The Sanctions Advisory specifically recommends foreign persons that “conduct transactions with or involving the United States or U.S. persons “to employ a risk-based approach to sanctions compliance.”

According to Scott Nance, Principal at Langley Compliance Consulting LLC, the guidance found within the Sanctions Advisory “represents international best practices” and “anyone responsible for sanctions compliance, whether in the United States or any other country, should review this Sanctions Advisory and make sure it’s incorporated in their organization’s procedures.”

The Sanctions Advisory also emphasizes suggested measures to be considered by financial institutions. This means that marine industry companies may see payments or funds transfers come under increased scrutiny as banks that finance the cargo are likely to adopt these recommended measures.

“As we know, the consequences of running afoul the sanction programs may be quite significant,” says General Counsel for a maritime company who prefers not to be named. “This means that parties involved in freight contracts may not be treated any differently than those parties engaged in the underlying commercial transactions itself,” they add.

Finally, it is important to note that the Sanctions Advisory is not legally binding and does not set forth requirements based in U.S. law.

Gina Venezia, Partner at Freehill Hogan and Mahar LLP in New York says, “The issuance of the Sanctions Advisory further underscores that international shipping is and will continue to be a focus of U.S. sanctions implementation and enforcement. She goes on to say that, “while the Sanctions Advisory does not impose requirements on vessel owners, insurers or others operating in the industry, those in the industry would be well-advised to consider carefully the steps and measures suggested in the Sanctions Advisory and incorporating same into their existing and developing sanction protocols.”