Understanding the Concept of “Ultimate Beneficial Ownership” in the Context of Sanctions and “Politically Exposed Person” Designations
Prospective customers, financial institutions, potential investors and business partners, as part of their due diligence procedures, are required to understand who are the ultimate beneficial owners (“UBOs”) of an entity they intend to engage with.  Under the recommendations of the Financial Action Task Force (“FATF”), used by most financial regulation professionals worldwide, the definition of beneficial ownership refers to the natural person(s) who ultimately owns or controls an entity. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.

When doing business with funds or other entities structured as limited liability partnerships, natural persons behind all Limited Partners (ownership requirement) as well as natural persons behind a General Partner (control requirements) are their UBOs.  This is relevant for Israeli companies considering an investment from or close cooperation with an overseas entity that has an opaque ownership structure.  For example, when a potential investor is an offshore limited liability partnership, conducting due diligence on that entity only would not be sufficient and will not likely provide any meaningful results.  Instead, one should request from a counterparty a detailed ownership structure of the entity in question and conduct appropriate due diligence on all of its UBOs.  When doing business with potential counterparts in jurisdictions like China or Russia, one of the important issues to be aware of is whether any of the counterpart’s UBOs is on a sanctions list or is a politically exposed person (“PEP”).

In the context of sanctions, knowing the UBOs of an entity is critical. Under the regulations of the U.S. Office of Foreign Assets Control(“OFAC”), even if an entity is not listed on OFAC’s sanctions list, but is 50%or more owned by an entity or person that is on the list, the same prohibitions apply to dealing with such entity.

Unlike with sanctions, when someone is either on the sanctions list or not, PEP analysis is a bit of a grey area. The criteria for what defines a PEP are broad, but most professionals rely on the following characteristics defined by FATF:
-  executives     of state-owned corporations;
-  heads     of government;
-  various     politicians;
-  military     or judicial officials;
-  upper-level     management of state-owned enterprises or international organizations;
-  board     members of state-owned enterprises or international organizations;
-  C-suites     of state-owned enterprises or international organizations;
-  directors     of state-owned enterprises or international organizations.

There are different approaches to how far to extend PEP status and there are different PEP databases that help track PEP status. Even if someone is not on a PEP database, one still can make an argument that someone is politically exposed due to management position or directorship in a company that is majority owned by a state-owned enterprise.

PEPs present a higher risk for KYC procedures by financial institutions and various other counterparties that are required as part of their normal operational activities. Receiving an investment or otherwise dealing with a party that is affiliated with PEPs does not mean that your company is in violation of any laws or regulations, but you should be aware of much higher scrutiny (including decision not to engage) by financial institutions and other counterparties involved that can make operating more difficult.  More specifically, financial institutions are generally required, in relation to foreign PEPs, to:
-  have     appropriate risk-management systems to determine whether the customer or     the beneficial owner is a politically exposed person;
-  obtain     senior management approval for establishing (or continuing, for existing     customers) such business relationships;
-  take     reasonable measures to establish the source of wealth and source of funds;     and
-  conduct     enhanced ongoing monitoring of the business relationship.  

From a potential customer perspective, having a PEP among your shareholders or as a director may, for example, have an impact on your ability to work on classified contracts.  It may also make access to finance more difficult, as some institutions may not be willing to lend into a structure with an investor who may have influence or control and who has a PEP status.
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