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Featuring Adam M. Smith, Senior Advisory to the OFAC Director and David Brummond, DLA Piper; Edited by Kristin Casler--
Corporate counsel doesn’t always have a good feel for the Treasury Department’s Office of Foreign Assets Control (OFAC) sanctions. Perhaps this isn’t surprising—after all, sanctions, just like the foreign policy that produced them, are constantly evolving, with their evolution, implementation and enforcement hard to follow for even the most seasoned observers.
Sanctions as a foreign policy instrument are in a constant state of flux: new sanctions programs are announced fairly frequently, new additions are made to existing sanctions regulations, and new sanctioned parties are frequently added to prohibitions (or removed from prohibitions). And, even if sanctions remain a moving target, one of the few constants is that as sanctions have become more complex, the enforcement of sanctions has become ever more severe. Consequently, no matter the seeming importance of any particular sanctions program or the nuances and pace of changes to sanctions measures, it remains vital to understand and comply with these measures in order to avoid potentially drastic penalties.
In a LexisNexis® Webinar in January 2015, David Brummond of DLA Piper and the former Senior Sanctions Advisor for Insurance at OFAC, and Adam M. Smith, the Senior Advisor to the Director of OFAC, provided some broad guidelines to help corporate counsel make sense of the ever-changing world of sanctions. They shared the long history of sanctions, outlined the fundamentals and structures that make up modern U.S. sanctions, and provided an update on the latest developments in sanctions regimes against Cuba, Iran and Russia.
Triple Tiers of Sanctions
Though the categories are not discrete, Brummond and Smith argued that it helps to think about U.S. sanctions as fitting into three categories. First, there are primary sanctions that apply to U.S. persons or entities, and traditionally have been the tool for implementing broad trade prohibitions on other countries or barring terrorists, drug dealers and weapons proliferators from the U.S. financial system. These sanctions identify entities (persons, organizations or companies) and freeze their assets in the United States and prohibit U.S. persons from engaging in dealings with them. While all U.S. sanctions programs have a primary sanctions component, some programs are augmented with a second category of sanctions—secondary measures, which implicate non-U.S. persons in their dealings with target states and threaten the non-U.S. persons’ access to the U.S. financial system. Secondary sanctions provide non-U.S. actors a choice: they can continue dealing with the targeted country and targeted companies or they can continue having access to the U.S. financial system. They cannot do both.
“Sectoral” sanctions are the third category (again appearing alongside primary and secondary measures) and they are a relative newcomer in the sanctions world, having only been applied (thus far) to address Russian aggression in Ukraine. The sectoral measures are surgical tools that target specific transactions made by specific entities in selected economic sectors. For instance, in the Russian case, sectoral measures, inter alia, limit the ability of select Russian financial institutions to access the U.S. debt and equity markets to raise funds. The institutions themselves are not sanctioned directly (as they would be under primary sanctions) nor are third-country entities that deal with these institutions necessarily at risk for losing their access to the U.S. financial system (as they would under secondary measures).
History helps put these seemingly modern financial tools into perspective. Brummond said that even if new sanctions are innovative over the two centuries during which sanctions have been imposed in the United States, some things have remained constant. Of note is the fact that the language of sanctions measures and regulations has always been imprecise. Sanctions regularly implicate the fortunes of specific businesses operating in specific markets—nuances about which the policy makers who write sanctions measures may be unfamiliar. Even so, the fundamental notion of sanctions—that “policy trumps profits”—means that businesses and their interests may suffer at the hands of sanctions measures. Indeed, the purpose of sanctions in some sense is for business to suffer—to deny a target country trade, economic growth or access to the financial system is the goal of sanctions. It is a feature rather than a bug of sanctions programs. Even so, over time, sanctions have become more sophisticated and more targeted, working hard to exact the greatest pain on the target of actions while mitigating the collateral consequences on U.S. and allied businesses.
Deciphering Primary Sanctions—The Case of Cuba
To examine how primary sanctions work, the experts focused on Cuba. U.S. persons and entities are prohibited under a range of regulations and laws from a large range of dealings involving Cuba, Cubans and Cuban property.
Primary sanctions apply to the exportation, sale and supply, directly or indirectly, of goods, technology or services.
Drilling down into the primary sanctions on Cuba, Brummond said the most critical provisions are the breadth of the prohibitions dealing with property restrictions. The regulations provide that no U.S. person can deal with transactions involving property in which Cuba has, at any time, had any interest of any nature whatsoever, direct or indirect.
“It’s very broad. It can be used as broadly as what a court or an agency would like it to be,” Brummond said.
So what is the impact of President Obama’s recent decision to ease sanctions on Cuba? Smith said that the sanctions and embargo, in large measure, remain intact.
“What has been removed are some of the difficulties with complying with sanctions, and it means that some of the exceptions that were already in place on a case-by-case basis have now become ‘generalized’,” Smith said.
For instance, Smith noted that the most wide-ranging changes concern travel to Cuba. Previously, to travel to Cuba, U.S. persons had to petition OFAC and demonstrate that they fit into one of several categories of permitted travelers to the island. If the agency agreed with the petition, the traveler would be granted a license to allow the travel. Since the changes to the sanctions, if a U.S. person believes that they are covered under one of the categories of permitted travel they can be automatically, “generally” licensed to proceed with the trip. They no longer need to come into OFAC for a license.
While it remains illegal for a U.S. person to travel to Cuba on a beach holiday or engage in general tourism, the 12 categories of permitted travel are very broad. These categories, which correspond with the President’s foreign policy objectives of empowering the Cuban people and encouraging people-to-people engagement, include family visits, official business of the U.S. or foreign governments, journalistic activity, professional research, educational activities, religious activities, athletic competitions, humanitarian projects, activities of private foundations or research or educational institutions, and support for the Cuban people.
A related change—also structured to empower the Cuban people—is that remittances can now flow more easily to Cuba. For the first time in decades, U.S. banks will be able to open correspondent accounts in Cuba, at Cuban banks. Also, telecom firms in the United States can establish necessary mechanisms and infrastructure to provide commercial telecommunications and Internet services in Cuba. There also are generalized exemptions for Cubans who reside in other countries to engage in normal commerce and normal trade with U.S. banks or a U.S. person, which was nearly impossible before.
As with all sanctions programs, Smith warned that the situation remains fluid and the sanctions may well change again.
A Primer on Secondary Sanctions—The Case of Iran
Iran is the quintessential case of secondary sanctions. Some primary sanctions on Iran had been in place on the country almost since the revolution in 1979. These primary sanctions have been gradually strengthened and today include a comprehensive prohibition on imports and exports of goods, services and technology to or from Iran, directly or indirectly. There are exceptions for food, agriculture, medical devices and similar goods, but as a general matter, Iran has been essentially off limits for trade.
The problem was that while U.S. primary sanctions were increased, other countries failed to follow suit. Consequently, even faced with the challenges of U.S. prohibitions, Iran was finding it fairly easy to continue their trade by turning to European, Asian or other institutions that were in jurisdictions that did not have similarly comprehensive measures. Brummond said that this leakage meant that the U.S. sanctions were only strict on the surface. Something needed to be done in order to strengthen these measures.
Congress finally acted in 1996 passing the Iran and Libya Sanctions Act. ILSA provided that if a foreign entity engaged in specific conduct denied to U.S. firms—like providing infrastructure to Iran—the United States could cut them off from access to the U.S. system. Importantly, the law doesn’t prohibit the conduct by a third-country firm—indeed, the U.S. does not have jurisdiction over third countries. However, the law, and subsequent laws similar to it, simply sets forth “secondary consequences” for firms that continue to engage in such work.
The breadth and power of secondary sanctions is hard to overstate. While certain secondary sanctions work differently, the most powerful threat has been the threatened cutoff of U.S. correspondent accounts for foreign financial institutions that continue to engage with certain Iranian actors. As a general matter, a correspondent account is what is needed for foreign banks to engage in U.S. dollar transactions. The vast majority of U.S. dollar trade—even between two non-U.S. trading partners—clears in the United States via correspondent banks. As such, if a bank loses its access to its U.S.-based correspondents, it is all but shut out of global trade. It is reduced, in the words of a Middle Eastern bank Smith briefed on this issue recently, to be a “piggy bank.” Trade finance and even international transactions of almost any sort become difficult, if not impossible to undertake.
Smith added, “The choice made clear by secondary sanctions is, you can deal with Iran or you can deal with the United States. You can no longer do both.”
Iran—Joint Plan of Action
U.S. negotiations with European nations and Iran recently produced a Joint Plan of Action, under which limited, temporary and reversible sanctions relief for Iran is in effect through June 30, 2015, Smith said. Existing sanctions remain in place and the relief focuses on only a few specific areas of trade—Iran’s petrochemical sector, gold and precious metals, inputs into Iran’s autos, Iran’s crude oil exports in specific ways, and civil aviation. The JPOA also provides a statement of licensing policy, allowing U.S. companies and others to engage with some Iranian air carriers, for safety and other reasons. Additionally, some repatriation of restricted funds abroad is allowed.
The Intricacies of Sectoral Sanctions—The Russia Case
Sectoral sanctions are the newest addition to the sanctions constellation and have thus far only been deployed against Russian entities. As in the case of secondary sanctions, sectoral sanctions come on top of primary measures and were similarly instituted in order to increase the pressure of sanctions beyond the level allowed by the primary measures. The primary sanctions on Russia are nonetheless quite robust and as of February 2015 include about 120 entities and individuals. These include top companies, some banks, defense firms and Russian government officials, all of whom have their U.S. assets frozen and are prohibited from dealing with U.S. persons, banks or companies.
Sectoral sanctions are comparatively complex and require a two-step process for implementation. First, the Secretary of Treasury is called upon to identify a sector of the Russian economy, and second, to identify firms in that sector upon which sanctions are to be placed. Even more confusingly, the sector sanctions have different consequences than either the primary or the secondary measures. As of February 2015, the sectoral sanctions identify specific entities in the energy, finance and defense sectors and rather than freeze their assets (as in primary sanctions) or threaten their access to correspondent banks (as in secondary sanctions), the sectoral measures limit the targeted firm’s ability to access U.S. capital markets or technology for specific projects that speak to their medium- to long-term growth prospects.
For instance, financial institutions are limited from raising specific tenors of debt or equity financing in the U.S. markets (which is needed for future growth), and energy firms are limited from accessing U.S. technology for new frontier drilling projects (also critical to future growth). The targeted firms include the largest Russian state-owned financial institutions, and many of the largest state-owned energy and defense firms. The goal of these measures was not to make them off-limits, but rather to pressure them into questioning whether their medium- to long-term interests are being best served by President Putin’s actions in Ukraine.
Smith said the intention was not to list the entire sector and make it off-limits to everybody—indeed, none of these sectorally targeted firms are blacklisted and U.S. persons can still deal with them. U.S. persons can even hold accounts at the Russian banks and otherwise engage with the Russian energy firms, so long as they do not provide prohibited debt, equity or technology.
As a result, sectoral sanctions move compliance from a question of the entity involved to the activity involved. Individuals and entities are not blacklisted. Complying with sectoral sanctions does not necessarily mean stopping and denying the transaction, but to scrutinize to ensure the underlying activity is not prohibited.
“That is very complicated from a technical implementation perspective, especially when you’re dealing with the huge volumes of transactions in which many of these firms participate,” Smith said.
OFAC Enforcement and You
OFAC enforcement activities have become much more active over time, and the potential consequences much more dire. Brummond and Smith provided an overview of how OFAC investigations and enforcement come about and what the risks are. OFAC investigations can be triggered by bank reports of blocked property, voluntary disclosures or through investigation of another matter or entity. Plus, Smith said, there may be referrals from other agencies or information obtained through public sources.
Enforcement cases may result in everything from no action to a criminal referral. The most common result of an enforcement action is the cautionary letter, which explains that there may be a problem, but not taking any formal action.
Factors considered in determining the outcome of an enforcement action include whether the conduct was willful or reckless—this is the primary factor. Then other questions are asked: Was the subject aware of the conduct? How much harm was caused? What was the amount involved, and how did it impact the goals of the sanctions program?
Consideration of individual characteristics includes whether the subject is a large, sophisticated business entity or just a relatively small regional player that got caught in a transaction. What type of compliance program did they have? What was the response when they found out about the violation? Did they cooperate with OFAC? When did this occur? How did it occur, and what other types of actions might be involved?
In determining a penalty, the agency has considerable discretion. Taking a $10,000 transaction as an example in a specific program, Brummond said that if the violation was self-disclosed and it was not egregious, a $10,000 transaction could earn a $5,000 penalty. However, if it was not self-disclosed and it was egregious, the base penalty would be $250,000. Additionally, maximum penalties vary by program.
Not surprisingly, the highest penalties have been assessed in the banking sector with headline-grabbing, multi-million- and even multi-billion-dollar penalties assessed in recent years.
And one must not forget that in most cases, OFAC and the Treasury are only two of several actors involved in the enforcement process. Penalties can come from other state and federal authorities, which ratchets up the cost of a sanction violation.
The key to avoiding stiff penalties is to remain current with sanction developments everywhere your company has business transactions.