Weapons Against Armour. What Do the ’Red Flags’ of Foreign Sanctions Regulators Mean?

The significant number of sanctions against Russia has naturally led to an increase in the number of attempts to circumvent them. If before the start of the Special Military Operation in Ukraine (SMO) in February 2022, investigations into violations of sanctions regimes against Russia were a rather rare phenomenon; over the past year and a half, their number has increased decisively.

The relevant government departments of the US, the EU and other initiators of sanctions are developing the practice of disclosing schemes for circumventing sanctions, identifying typical signs of such attempts and summarizing Russia's experience adapting to new restrictions. A classic situation of “arms and armour” confrontation arises, when the tightening of pressure leads to the search for ways to adapt to it, and the experience of adaptation is taken into account by the initiators in order to optimise the pressure. However, in the case of sanctions, this confrontation will not last forever. It is easier for Russian business to avoid sanctions than to bypass them and risk criminal prosecution. In other words, by opting to work with friendly jurisdictions, they minimise or nullify ties with Western partners, amid their growing toxicity and riskiness.
Summarising official documents, one can single out a number of “red flags” that are considered by the initiators of sanctions as indicators of circumvention of restrictive measures or, at least, suspicious transactions.

Along with criminal cases, the number of cases of secondary sanctions, that is, blocking financial sanctions for transactions in favour of previously blocked persons, is also growing. Since the beginning of 2023, the US Treasury has imposed such sanctions on people from China, India, Armenia, Kyrgyzstan, Switzerland, Liechtenstein and a number of other countries. Such measures usually do not lead to diplomatic friction between the United States and the authorities of these countries. Moreover, representatives of the authorities of the US, the EU and other initiating countries are actively conducting "explanatory work" with the business of those countries that have not joined the Western sanctions. "Red flags" are among the recommendations. The purpose of such work is to rely on the fact that even if a country friendly to Russia does not impose sanctions against it, businesses will be more cautious and evade transactions. To some extent, this scheme works. An indirect confirmation is, for example, the caution of banks in friendly countries in dealing with Russian counterparties. However, the size of the Russian economy is such that import and export operations will remain in demand, and business will look for workarounds. Sanctions drive entrepreneurs to pursue transactions that are potentially risky for them, distorting normal market relations. But the same market logic will push businesses to further adapt to sanctions regimes. At the same time, business is interested in minimizing risks. Therefore, an increasingly optimal strategy for entrepreneurs is a complete withdrawal from the Western markets, the search for alternative suppliers in friendly countries, as well as reliable mechanisms for financial transactions that are not related to the US dollar or other Western currencies. 

Strategically, the optimal strategy is not to circumvent sanctions, which are fraught with criminal prosecution and other legal risks, and to avoid risk as such. The "Turn to the East" thus receives nourishment in the form of rational business behaviour to derisk its activities.

The significant number of sanctions against Russia has naturally led to an increase in the number of attempts to circumvent them. If before the start of the Special Military Operation in Ukraine (SMO) in February 2022, investigations into violations of sanctions regimes against Russia were a rather rare phenomenon; over the past year and a half, their number has increased decisively.

The relevant government departments of the US, the EU and other initiators of sanctions are developing the practice of disclosing schemes for circumventing sanctions, identifying typical signs of such attempts and summarizing Russia's experience adapting to new restrictions. A classic situation of “arms and armour” confrontation arises, when the tightening of pressure leads to the search for ways to adapt to it, and the experience of adaptation is taken into account by the initiators in order to optimise the pressure. However, in the case of sanctions, this confrontation will not last forever. It is easier for Russian business to avoid sanctions than to bypass them and risk criminal prosecution. In other words, by opting to work with friendly jurisdictions, they minimise or nullify ties with Western partners, amid their growing toxicity and riskiness.

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Regulators in the United States, EU countries, Canada and other initiators of sanctions have issued a number of documents that summarise the experience of dealing with circumvention of sanctions and provide practical recommendations for stopping such transactions. They partly overlap with the experience that has been gained in countering the circumvention of sanctions against Iran, North Korea, Venezuela and other jurisdictions. However, the specifics of the Russian case are to be found in the size of the Russian economy and the level of its technical integration with the West, accumulated over the past 30 years. Accordingly, approaches to monitoring the sanctions against Russia are also being updated.

Summarising official documents, one can single out a number of “red flags” that are considered by the initiators of sanctions as indicators of circumvention of restrictive measures or, at least, suspicious transactions.

Given that the enforcement of the sanctions regime is the responsibility of the business, regulators consider red flags as part of the counterparty verification algorithm that companies build into their system of sanctions compliance—systems for monitoring compliance with the sanctions regime.

The first such indicator is the participation in the transaction of persons or organizations from countries that have not imposed sanctions against Russia. A typical situation is when a product prohibited for import into Russia is purchased by a person from a third country, and only then enters Russia. Large banks and corporations, especially those with markets in the West, are very wary of working in sanctions jurisdictions. This does not prevent small firms, sharpened directly to work with Russia, from acting as intermediaries. Therefore, a number of other "red flags" are associated with the characteristics of counterparties involved in the transaction. Warning signs include, for example, the date of registration of the company. If it was established after February 2022, then it could potentially be a company created to work with people under sanctions. The same applies to legal entities that have been inactive for a long time, but resumed their activities against the backdrop of new sanctions. The "flag" becomes even more "red" if such a company has a weak digital footprint, or none at all. The absence of a website on the Internet or a website that was clearly created in haste and with the most general information is a reason to flag the company. Attention is also drawn to the services it offers. For example, operations with dual-use goods, especially in electronics and some other high-tech niches, are a "red flag". There are also atypical transactions here, when a company provides some services, but suddenly switches to others related to goods subject to export control or financial transactions with sanctioned persons. Countries that are part of the anti-Russian regimes of restrictive measures can also be used as an intermediary jurisdiction for the supply of sanctioned goods.

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One of the scenarios is where an order is placed in the USA for this or that product by a firm in an allied country that is not affected by export controls, with the subsequent delivery of the product to Russia.

The next group of indicators is related to the nature of the transaction. Trying to split a transaction into many smaller transactions is a red flag. It says that the company does not want to get on the radar of financial intelligence in connection with the volume of funds spent or goods supplied. Another sign is excessive supply complexity. It can be expressed as a large number of intermediaries winding through several jurisdictions. The nature of the ownership structure is also an indicator. Changing the structure by transferring assets to relatives or trusted persons, in the understanding of Western regulators, can be a veiled attempt to remove the asset from sanctions.

Another group of indicators implies explicit attempts to distort information about the nature of the transaction or data about the counterparty. Among them—changing the dates of the conclusion of contracts, information about the end user, replacing product codes, embedding a product under sanctions in a product that is not covered by sanctions, distorting information about individual components included in the product, and attempts to change the data of tracking devices and monitoring systems movement of goods and vehicles. Here you can also note the disproportionately high fees to consultants, lawyers and other persons who accompany the transaction. An important sign is the desire of the counterparty to conduct a transaction using virtual currencies.

Recent criminal cases filed in the US and other Western countries on suspicion of the circumvention of the sanctions regime indicate the presence of a number of "red flags" in the alleged violations. One example is the criminal case against Russians Yevgeny Grinin, Alexei Ippolitov, Boris Livshits, Svetlana Skvortsova and Vadim Konoshchenko, as well as US citizens Alexei Breiman and Vadim Yermolenko, who are suspected of bypassing US export controls. The case file points to the creation of a number of intermediate legal entities in the United States, the alleged forgery of documents, as well as an attempt to import defence goods to Russia from the United States through Estonia. Vadim Konoschenko was arrested in Estonia and extradited to the USA. Another recent example is the arrest in the US of Russian citizens Oleg Patsuli and Vasily Besedin. They are accused of trying to supply aircraft parts to Russia, bypassing US export controls through legal entities in third countries. In another high-profile case, the Russians Artem Uss, Svetlana Kuzurgasheva, Yuri Orekhov, Timofey Telegin and Sergey Tyulakov stand accused of supplying dual-use goods from the United States to Russia via Germany and Malaysia, as well as dealing in the circumvention of the US sanctions regime against Venezuela. The number of such criminal cases has increased since February 2022, although there were precedents earlier. A resonant case was, for example, the accusation, arrest and subsequent verdict against a Russian citizen, Oleg Nikitin, and his partners in the United States and other countries. They were accused of trying to import a Vectra 40 G turbine into Russia via an intermediary company, bypassing US export controls.

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Common to many criminal cases is that the basis for the accusatory documents is the electronic correspondence of the participants in the transaction, as well as signals to the authorities from the manufacturing companies, which were contacted by the accused Russian citizens and their partners.

Along with criminal cases, the number of cases of secondary sanctions, that is, blocking financial sanctions for transactions in favour of previously blocked persons, is also growing. Since the beginning of 2023, the US Treasury has imposed such sanctions on people from China, India, Armenia, Kyrgyzstan, Switzerland, Liechtenstein and a number of other countries. Such measures usually do not lead to diplomatic friction between the United States and the authorities of these countries. Moreover, representatives of the authorities of the US, the EU and other initiating countries are actively conducting "explanatory work" with the business of those countries that have not joined the Western sanctions. "Red flags" are among the recommendations. The purpose of such work is to rely on the fact that even if a country friendly to Russia does not impose sanctions against it, businesses will be more cautious and evade transactions. To some extent, this scheme works. An indirect confirmation is, for example, the caution of banks in friendly countries in dealing with Russian counterparties. However, the size of the Russian economy is such that import and export operations will remain in demand, and business will look for workarounds. Sanctions drive entrepreneurs to pursue transactions that are potentially risky for them, distorting normal market relations. But the same market logic will push businesses to further adapt to sanctions regimes. At the same time, business is interested in minimizing risks. Therefore, an increasingly optimal strategy for entrepreneurs is a complete withdrawal from the Western markets, the search for alternative suppliers in friendly countries, as well as reliable mechanisms for financial transactions that are not related to the US dollar or other Western currencies.

Strategically, the optimal strategy is not to circumvent sanctions, which are fraught with criminal prosecution and other legal risks, and to avoid risk as such. The "Turn to the East" thus receives nourishment in the form of rational business behaviour to derisk its activities.