Investigating Ultimate Beneficial Ownership in Ukraine

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By Vlada Tkach

A Ukrainian company seeking a partnership with a western credit organisation states on paper that it is ultimately owned by a Cypriot-based lawyer or a no-profile individual based in the British Virgin Islands, but then discloses in talks that its owner is actually a well-connected local oligarch. He just prefers not to advertise his connection to the business. This type of situation has been all too common for anyone who has ever been involved in a business relationship in Ukraine.

In fairness, the same can be said of Russia, Kazakhstan, Azerbaijan and many other states that have emerged from the former USSR. In-transparent beneficial ownership, especially by oligarchs who often acquired their assets in less-than-lawful ways, as well as associated corruption, has been ingrained in the business culture of some post-Soviet states.

In Ukraine, corruption, historically, has been among the highest in the post-Soviet space, while monopolisation of markets and state capture by oligarchs, who continue to hide their assets from public scrutiny, is considered one of the greatest obstacles to foreign investment (1).

The reasons for concealing ultimate ownership of assets are not unique to Ukraine. They include tax evasion, encashment and illegal withdrawals of assets by the owners, a desire to hide associations with political parties, and the disguising of loans to affiliates.

Since the fall of Viktor Yanukovych’s regime as a result of the Euromaidan revolution in 2014, Ukraine has made significant progress in transparency in many areas, from public procurement and state spending to the financing of political parties and income disclosure by public sector officials. Transparency in beneficial ownership of companies and property has also been increased, however, progress has been patchy.

Legislation on company ownership disclosure

The main source of publicly available information about the beneficial ownership of Ukrainian companies is the Unified State Register of Legal Entities and Individual Entrepreneurs (USR) (2). Under the Law “On State registration of legal entities, private entrepreneurs and public institutions”, USR contains information on legal entities, physical persons/entrepreneurs and public organisations, including information on the ultimate beneficial owners (controllers). USR has been available in Ukraine in its current form since 2015, and is the most comprehensive, official database of Ukrainian companies.

The legislative base for implementation of beneficial ownership disclosure in Ukraine is extensive and includes the following laws:

  • Law of Ukraine “On State registration of legal entities, private entrepreneurs and public institutions”;
  • Law of Ukraine of 14.10.2014, No1702, “On prevention and counteraction of legalization laundering) of incomes to be obtained through criminal actions, terrorism financing and financing distribution of weapons of mass destruction”;
  • Economic Code of Ukraine (Art. 641);
  • Law of Ukraine of 21.05.2015, No 475-VIII, “On amendments to certain legislative acts of Ukraine on information on final beneficial owner (controlling interest) of legal entity”;
  • Law of Ukraine of 14.10.2014, No 1701-VII, “On amendments to certain legislative acts of Ukraine on defining the final beneficiaries of legal entities and public figures”.

These documents, among other things, stipulate the definition of ultimate beneficial ownership, establish an institutional base for implementation of beneficial ownership disclosure, provide information about politically exposed persons (PEPs), and outline the level of detail to be disclosed. But the devil is in the details – or, rather, in the legal loopholes in the Ukrainian legislation, and the absence of verification mechanisms.

Limitations on enforcing ownership transparency

For example, the ultimate beneficial owner cannot be an agent, nominal holder (nominal owner) or mediator who has 25 percent or more authorized capital or voting rights in a legal entity. In theory, therefore, a Cyprus-based lawyer should not be listed as the ultimate beneficial owner in the official documents. In reality, however, this is often the case, as there is no reliable mechanism for verifying the information provided by the companies. All data is entered into the USR by state registrars (notaries) who obtain this data from the very same legal entities. The Ministry of Justice, the manager of the USR, should theoretically be verifying the information submitted. But although the Ministry of Justice can carry out audits of suspicious entities and force them to reveal true information, such audits are rare and impractical.

Legal definition
According to Ukrainian law, the  ultimate beneficial owner is defined as the “natural person that, independently from formal ownership, has the right to execute decisive influence on the management or economic activity of a legal entity directly or via other persons, through the realization of his ownership right or right to use all active assets or significant parts thereof, right of decisive influence on composition, results of voting and consummation of deals that provide the option to define conditions of economic activity, give binding instructions or fulfil functions of managing body, or that has the possibility to exert influence by direct or indirect (via other individual or legal entity) ownership by one person singly or together with other related individuals or legal entities of share in legal entity in amount 25 percent or more of authorized capital or voting rights in legal entity”.

Moreover, according to the Law of Ukraine dated 14 October 2014 “On amendments to certain legislative acts of Ukraine on defining the final beneficiaries of legal entities and public figures”, failure to submit the information on beneficial owners comes with a fine of three hundred to five hundred untaxed minimum incomes (currently totalling between UAH 5,100, or EUR 160, and UAH 8,500, or EUR 260) which is not significant enough to deter non-compliance.

With regards to submitting false information, under Article 4 of the cited Law, persons who are responsible for submitting untrue information to the USR, are subject to criminal liability. However, to prove that the information submitted by a company is false and that a Mr X, listed as a beneficial owner, is in fact a frontman, you would need to launch criminal proceedings, and make enquiries through State Financial Monitoring, which would take years. Ukrainian companies thus can list among their beneficial owners pretty much whoever they want. In August 2015, for example, Ukrainian State Center of Radio Frequencies, a state entity, awarded a series of contracts for the supply of spectrum analysers worth UAH 9.64 million (over EUR 300,000) to an LLC Research and Production Association Romsat (3), whose ultimate beneficial owner was listed as “Agamemnon Anonymous”, a Cyprus citizen. Ukrainian investigative journalists established that the real owner of the company was likely to be a Ukrainian MP, who in the past worked as Head of the Corruption and Organised Crime department of the Security Service of Ukraine.

There are other legal loopholes, too. If company founders are individuals who are also its beneficial owners (but where none of the individuals meets the definition of the ultimate beneficial owner, i.e. exercises decisive influence over the company, etc.), information about ultimate beneficial ownership does not have to be submitted. Therefore, it is not rare to find Ukrainian companies that state in the USR that they do not have an ultimate beneficial owner at all. In some cases, where companies involved are high profile and widely associated with certain businessmen, the connections are easier to detect even if they are absent on paper. But in cases of smaller or less known firms, establishing ultimate beneficial ownership may still be problematic.

Moreover, joint stock companies (JSCs) are not obliged to report their ultimate beneficial ownership information in the USR – they must disclose it to the Stock Market Infrastructure Development Agency (SMIDA). SMIDA is also open to the public, but JSCs must only report on owners of 10 per cent or more of the company’s shares. This means that many companies simply split shares among several formally unrelated owners that hold less than 10 percent each, and thus do not have to provide information on those shareholders and the number of shares they own. Once again, these shareholders are usually only nominal owners.

The situation in the banking sector, where the number of actors is limited and where the regulator, the National Bank of Ukraine, has been much stricter, is better. In 2016, for example, the TK Credit bank was declared insolvent and subsequently lost its license due to non-transparent ownership structure. But overall, verification of the ownership is an issue: the EU is now on the brink of withholding its third macroeconomic aid tranche, of EUR 600 million, due to Ukraine’s failure to introduce, among other things, the system of verification of information on beneficial ownership of companies.

Review of digital avenues to beneficial ownership information

Beyond the USR, there are now other, indirect, avenues for establishing beneficial ownership of Ukrainian companies. One of them is the e-declarations system for the assets of public-sector officials. The system was launched by the National Agency for the Prevention of Corruption (NAPC), the new body responsible for developing and managing Ukraine’s anti-corruption programmes, in September 2016. Initially, it required 100,000 senior officials in government, including the President and the Prime Minister, to disclose their income and assets, as well as those 
of their family members. The results of the first wave of e-declarations caused outrage among Ukrainians: the declared cash holdings of Ukrainian officials alone reached UAH 26 billion (around EUR 815 million). But along with luxury watches, cars, paintings and property, the e-declarations also contained information on corporate holdings of the Ukrainian officials. Some of them were forced to reveal ownership of both Ukrainian companies and offshore vehicles, leading to an unprecedented exposure of enrichment among officials that so far is without parallel in the countries of the former Soviet Union.

National Agency for Prevention of Corruption (NAPC)

The NAPC is responsible for developing and implementing the anti-corruption strategy. One of its main tasks is verifying the asset declarations of state and local government officials. It is also responsible for enforcing rules on political party financing, including the use of state-allocated support that is provided to political parties.

National Anti-Corruption Bureau of Ukraine (NABU)

The NABU is responsible for investigating corruption committed by senior officials, members of parliament, judges and managers of large state-owned enterprises. It operates independently of the Prosecutor General’s Office (PGO). The NABU’s director was selected in an open competition with the involvement of civil society. With the exception of its first deputy and deputy directors, all NABU positions are filled by open competition.

However, while the e-declaration revelations have contributed to establishing some of the beneficial interests behind many Ukrainian businesses, allowing investigators access to the trove of information, there has been a woeful lack of action on behalf of NAPC with regards to the timely checking of data, required for potential criminal investigations by the newly formed agency for investigating high-level official corruption, the National Anti-Corruption Bureau of Ukraine (NABU). Similarly, with the USR, there is no system of automatic verification of e-declarations – the EU identified this as one of the grounds for withholding the latest tranche of financial aid.

Another resource for establishing beneficial ownership of companies and property assets is the public real estate registry, which was launched in January 2015. This is an online database that allows every Ukrainian to retrieve real estate ownership information. For a small fee, the real estate database allows searches to be undertaken by name, address, etc., to reveal names of property owners, building maintenance records, and its mortgage history. However, while the register is a step forward for transparency, enabling background checks to be carried out and real estate deals to be monitored more easily, commentators say the system is flawed. A lot of information is missing: most records prior to 2012 have not been digitalised and are not in the system. There are data entry errors, and ownership history is not available.

A Ukrainian due diligence consultant said that because of these issues, searches often need to be duplicated with different parameters. “For many years, the information on real estate was only kept by local Inventory Bureaus, and only in hard copy. Many of these records have not been transferred into the electronic format. So often, we have no idea what information is in the register and what is not, and you have to keep looking and double-checking.”

Moreover, while the Ministry of Justice is responsible for keeping real estate data, land documentation is administrated by another institution – StateGeoCadastre – an executive body agency overseen by the Cabinet Ministers of Ukraine. StateGeoCadastre registers land ownership and manages the state land cadastre.

Justice Minister Pavlo Petrenko recently said that both registries should be merged to eliminate the possibility of abuse and raider attacks: even though StateGeoCadastre keeps its registry mainly in electronic format, there are still a lot of hard-copy records, which are more difficult to search. In August this year, Pavlenko said that this would be taken care of once the StateGeoCadastre was placed under his ministry’s jurisdiction. Oleksiy Viskub, Deputy Head of the State Agency on Issues of Electronic Government, said the agency plans to use block chain, an encrypted technology that links and stores data in chains, to upgrade the register by the end of 2017.

Finally, another useful resource for checking beneficial ownership of companies is the Unified State Register of Court Decisions (USRCD). This tool is relatively old: it was opened to the public in 2006. Experience shows that litigation documents related to corporate disputes often reveals the involved parties and vested interests that may not be officially linked to the participants of the disputes. However, while USRCD is open to the Ukrainian public, access to foreign IPs has been closed since mid-2017. According to Dmytro Dubinko, Deputy Director General of the State Enterprise Information Judicial Systems, which is responsible for maintaining the register, his agency was forced to close the register to foreign visitors after several major hacking attacks in 2017 severely affected its work. However, a new, better protected version of USRCD is supposed to be launched in 2018.

The research possibilities of USRCD are also limited, however, as majority of names of individuals that are involved in litigation are blanked out, and some decisions are closed all together, due to privacy restrictions.

Overall, the situation with transparency of the beneficial ownership has undoubtedly improved in Ukraine, and there is now legislative base that requires companies to disclose the interests behind them. However, until valid and reliable verification mechanisms are in place, the possibilities for hiding beneficial ownership, including that linked to PEPs, remain rife. Moreover, the beneficial ownership alone cannot provide answers to many questions regarding business transparency that investors have – it is the understanding of the political and economic context that continues to be the key, and here no register or database, even the fullest and the most reliable, can replace the human intelligence.