Why Subsidiary Company Due Diligence is Crucial for Compliance Success

Establishing a subsidiary company is a common practice for multiple reasons, including localization, strategically utilizing tax benefits within legal limits, or risk mitigation. 

Subsidiary companies offer many advantages to both the parent company and the subsidiary itself. However, they can create challenges for effective Anti-Money Laundering (AML) and sanctions compliance monitoring.

While doing the due diligence for AML or sanctions compliance, it is very important to know the subsidiary company. This is because, even if a subsidiary is not subject to sanctions or is not located in a high-risk jurisdiction for money laundering, its parent company may be. 

Subsidiary Company Meaning | All You Need to Know

A subsidiary company definition refers to a parent company gaining control of an entity by owning a majority of the voting shares of the entity. The parent company appoints the majority of its board members through contractual methods. 

Subsidiary companies are independent and function on their own. However, their parent company may also benefit them from time to time by providing them with some additional resources and infrastructure. This allows the subsidiary companies to be more flexible in their operations and cater fully to the needs of their businesses. 

Types of Subsidiary Companies

MTN Group Under Scrutiny for Alleged Sanction Violations

The South African telecom company MTN Group faces investigation because it acquired forbidden American technology through third-party vendors for its Iranian operation, MTN Irancell. 

MTN conducted internal discussions regarding U.S. product acquisition for wiretapping services, while also considering the risks associated with sanctions. As part of obtaining the equipment, the company utilized local Middle Eastern agents and tapped into black market networks. 

The MTN stance rejecting misconduct demonstrates the need for companies to validate subsidiary activities, as it prevents sanctions violations, which can lead to legal complications and detrimental reputational damage. 

Why Due Diligence On Subsidiaries Matters?

MTN Group faced scrutiny for dealing with a sanctioned subsidiary by providing unlicensed services and importing export-controlled technology. It is important to perform due diligence before partnering with subsidiaries. This helps avoid any risks associated with sanctions. 

Additionally, businesses with operations exposed to diverse AML Compliance regulations and sanctions regimes need to ensure strict third-party assessment.  It incurs financial losses and experiences legal penalties, while developing adverse reputational effects. Let’s look at some of the most important risks:

Hidden Ownership Structures of Businesses

The extensive networks of subsidiaries, joint ventures, and related entities that many large corporations maintain across jurisdictions make it difficult to identify their Ultimate Beneficial Owner (UBO). 

These complex organizational arrangements have the means to conduct secretive ownership operations, money laundering, and even sanctions evasion if these entities are listed in any sanctions regimes.

Suspicious entities with ill intent use legal ownership structures, such as nominee directors and different legal entity structures. This means that authorities find it very hard to catch illegal finance or trade. 

AML Regulatory Exposure

As part of AML compliance, the Financial Action Task Force (FATF) (recommendation 10) suggests that companies should adopt enhanced due diligence processes if there are any complex ownership structures that are involved. This also includes any structures with subsidiaries. 

Additionally, inadequate oversight of subsidiaries may lead to enforcement actions, substantial fines, and irreparable reputational damage.

Sanctions Risks

When a subsidiary fails to comply with sanctions regulations, the entire corporate group becomes liable for penalties.

For instance, the U.S. International Emergency Economic Powers Act (IEEPA) and the EU’s Sanctions Regulation (EU) 269/2014 extend the reach of sanctions laws to subsidiaries operating in or transacting with sanctioned countries or entities.

Example: The entire parent company group becomes vulnerable to penalties when its subsidiary conducts unintentional business with a sanctioned entity, which can lead to heavy fines and restrictions on how the business operates.

Another case includes when a company or any business entity does business with a subsidiary whose parent entity has been sanctioned, which is known as a sanction by extension. This also results in heavy regulatory penalties and fines.

Operational and Reputational Integrity

Subsidiaries are often located in jurisdictions that do not have very strict governance or regulatory bodies overseeing operations or enforcing AML rules. 

A subsidiary’s involvement in fraud alongside bribery activities and human rights abuses would inflict major damage to its parent company’s reputation if appropriate checks are not in place.

Verifying the Subsidiary Companies | Key Steps in Due Diligence 

A proper business verification for a company subsidiary covers several critical areas to ensure compliance with laws and minimize any risks.

• Ownership & Control Mapping

Identify every layer of shareholding, director appointments, and voting agreements to trace ultimate beneficial owners (UBOs). This mapping helps uncover any concealed ownership or hidden control structures.

• Sanctions Screening

All companies under subsidiaries, together with directors and UBOs, need to be screened against the global sanctions lists provided by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC), United Nations, and European Union.

Screening UBOs, such as parent companies, their directors, or shareholders owning 50% or more of subsidiary companies, is important for anyone who wants to identify risks associated with sanctions or ensure compliance with regulations. 

• AML/CFT Risk Assessment.

Look at the legal risks in each country and the specific risks of the business sector, and check how the local unit has followed compliance rules in the past.

Businesses in high-risk locations alongside specific operational sectors must receive special attention during the due diligence process by financial institutions that deal with vital matters.

• Corporate Documentation Check

Review Articles of Association, shareholder registers, and board minutes to identify any risks related to transactions that are not obvious at first glance. Additionally, it identifies conflicts of interest or potential compliance risks. These documents also provide insight into the corporate governance framework of subsidiaries.

• Ongoing Monitoring

A real-time alert system should detect changes in shareholding and director information, as well as negative media reports regarding the company or its shareholders. 

Businesses should ensure continuous monitoring to detect early warning signs, which enable them to prevent risks from escalating.

How The KYB Product Strengthens Your Subsidiary Company’s Due Diligence

A subsidiary company with a separate legal status does not isolate it from the parent’s compliance obligations, especially under strict AML and sanctions rules. Whether you are onboarding a new subsidiary or re-certifying an existing entity, diligent due diligence is no longer an option, but essential. 

The KYB is a powerful solution for managing the risk associated with subsidiary verification and due diligence. This platform enables businesses to automate many of the tasks involved in subsidiary monitoring, ensuring the company remains compliant with AML sanctions regulations. 

The KYB provides data on business owners of the company directly from official registries in each state, with real-time checks against over 215 sanctions regimes, 3,500-plus watchlists, and politically exposed person databases.

Therefore, don’t wait for the risk to escalate. Integrate The KYB dashboard today to protect your business from subsidiary-related compliance failures.

Frequently Asked Questions

• What Does It Mean To Be A Subsidiary Of A Company

A subsidiary is a company that is controlled by another company, known as the parent company, typically through majority ownership of shares.

• Is A Subsidiary The Same As An LLC?

No, a subsidiary is a company owned by a parent company, while an LLC (Limited Liability Company) is a specific legal structure for businesses.

• What Companies Are Subsidiaries?

Subsidiary company examples include Google, a subsidiary of Alphabet, and Instagram, a subsidiary of Meta.

• Who Owns A Subsidiary Company?

A subsidiary is owned by a parent company, which holds a majority of the subsidiary’s shares or voting rights.

• What Are Sister Companies?

Sister companies are two or more companies that are owned by the same parent company but operate independently of each other.