As businesses rely on more complex networks of vendors and third parties, verification of these entities becomes increasingly important
As global economies have become more interconnected, businesses rely on increasingly complex networks of vendors and third parties to provide them with the goods and services they often need for their own production.
Working with these vendors exposes businesses to various risks and challenges such as fraud, corruption, reputation-damaging environmental and social issues, and regulatory violations. It is essential for companies to verify and monitor those parties with which they do business and ensure their third parties comply with relevant laws and standards within their industry and jurisdiction.
Regulators and authorities expect businesses to perform due diligence and provide necessary disclosures on their vendors. Failure to fulfill these obligations can lead to fines and legal accountability, with potential consequences, such as trade embargoes, asset freezes, and travel bans.
The U.S. Customs and Border Protection, for example, recently seized 1,000 shipments of solar energy components due to suspicion of slave labor used in the imports from China’s Xinjiang region. While the products were held in custody, the company faced 30-day storage expenses. In accordance with the Uyghur Forced Labor Prevention Act, companies are required to provide evidence that their goods are not produced using forced labor if there are suspicions of human rights violations. Failure to substantiate this claim could result in the destruction or re-export of the products at an additional cost to the company.
Sanctions in particular have become more prevalent since 2021. Sanctions imposed by the United States in the wake of Russia’s invasion of Ukraine have focused on Russia’s biggest financial entities, which hold 80% of the country’s banking assets with an estimated value of almost $1.4 trillion and will not be able to raise money through the U.S. market. In the same year, Canada’s sanctions list also witnessed a remarkable surge of more than 100% growth. The European Union along with other G7 nations and Australia have impeded access to €300 billion from the Russian Central Bank. These regulations and more are driving the need for robust vendor due diligence.
Beyond basic corporate information
Businesses are looking beyond basic corporate information to assess beneficial ownership, including identifying connections to politically exposed persons (PEPs) or individuals on sanctions lists. To mitigate risks associated with sanctioned individuals, it is essential to screen multiple relationship types including associates and to ensure that new affiliates are not linked to individuals or entities subject to sanctions. What’s more, corporate structures, including subsidiaries, distributors, and partners are often subject to scrutiny due to the potential use of shell companies in offshore countries for financial misconduct, money laundering, and fraud.
A recent Thomson Reuters Risk & Fraud study, Combatting business-to-business fraud: 2023 benchmarking report, highlighted the significance of ascertaining beneficial ownership especially when dealing with companies potentially owned by oligarchs or PEPs. Despite export restrictions to Russia, some companies connected to oligarchs still manage to supply goods, making continuous monitoring of vendors and third parties vital. Former FBI official Charles McGonigal, for example, recently admitted to using shell companies and forged signatures to receive payments from Russian oligarch Oleg Deripaska, thereby evading U.S. sanctions.
The process of verifying vendors and third parties
Higher volume and dollar value relationships require greater accuracy and enhanced due diligence. For example, screening important distribution partners requires thorough vetting and in-depth due diligence; and as such, the process should be regarded as less time-sensitive to ensure that a high-quality review occurs. Allocating resources based on a risk-based approach helps guarantee that higher-value relationships receive a more comprehensive review.
Assessing vendors on their ethical practices, commitment to social responsibility, and any legal issues remain ongoing areas of concern. To mitigate such risks, companies should do real-time searches based on public records data and proprietary data that can be categorized and translated into risk factors. By using a data analytics program, companies can quickly categorize vendors into different risk levels, allowing companies to then prioritize time and resources on higher-risk vendors while expediting the verification process for lower-risk ones.
Finally, the lack of integration with core business applications and processes can also be challenging. Many companies use technology or software solutions that do not integrate with their existing systems, thus creating inefficiencies. To overcome these challenges, companies must invest in solutions that are tailored to their specific needs and integrate those new solutions seamlessly with their existing systems.
As businesses expand their global networks, they are increasingly exposed to more risks, including fraud and sanctions violations. The importance of knowing your vendors and third parties cannot be overstated amid this heightened regulatory environment.
To protect themselves from potential legal and regulatory damage, companies must be prepared to invest in robust risk-based solutions that enable accurate and complete due diligence on their vendors and other third parties.