Coping with the Changing Landscape
Written by Jonathan Epstein & Tom Morante
The last several years have witnessed dramatic changes in the scope, complexity and enforcement of economic sanctions, perhaps best evidenced by the rapid increase and recent relaxation of certain sanctions on Iran. Keeping pace with these changes presents practical challenges for companies doing business internationally. How each company addresses sanctions compliance is dependent, among other factors, on the nature of their business, their geographic footprint, the products and services they sell and their overall compliance mentality. This article discusses recent changes in Iran sanctions and also takes a step back to look at the long term trends in sanctions and how these affect compliance. It also provides tips for avoiding some common sanctions compliance pitfalls and discusses how companies can strategically plan to address changes in sanctions laws and mitigate sanctions risk.
THE CURRENT STATE OF PLAY WITH IRAN SANCTIONS
For several years, the U.S., the European Union and certain other countries have been ratcheting up sanctions on Iran, which, in turn, have significantly affected the Iranian economy. The sanctions have been effective due in large part to the multi-lateral approach and the focus on closing down the ability of Iran to sell major export products, such as oil and petrochemicals and to conduct transactions globally through major financial networks.
After months of negotiations, the five permanent members of the UN Security Council (the U.S., UK, France, Russia, China) plus Germany (the P5+1) agreed on a set of temporary suspensions of certain sanctions in return for Iran making specific concessions on its nuclear program. These suspensions went into effect on January 20, 2014 and will expire July 20, 2014, unless extended. The suspensions are both measured and limited and, to some extent, reflect a delicate and much written about political balance. As a result of these suspensions, U.S. companies will be able to obtain licenses on an expedited basis to export civil aviation repair parts to Iran and to repair Iranian civil aircraft. Extraterritorial sanctions on Iran’s export of petrochemicals and on the import of parts for Iran’s auto industry are suspended. Further, the provision of associated services such as transportation, insurance and finance will be permitted for non-U.S. entities. And those few countries importing oil from Iran will be able to continue to import at current levels, without risk of sanction. In addition, Iran will be allowed to repatriate and recognize several billion dollars in oil revenue that has been effectively blocked by sanctions.
There is precedent for using the relaxation of sanctions as a U.S. foreign policy tool. The U.S. has, with some success, used the past measured relaxation of sanctions against Libya and Burma as a tool of foreign policy. If the current rapprochement continues, we would expect to see a gradual lifting of additional sanctions on Iran. There is, however, real skepticism in the U.S. Congress regarding this approach and Congress may through legislation create an environment where such rapprochement is impossible. Conversely, the Ruhani government may be unable to meet its commitments regarding its nuclear program. Further, while the negotiations have solely focused on Iran’s nuclear program, it is difficult to envision the U.S. significantly rolling-back sanctions on Iran as long as Iran continues to aggressively support Hamas, Hezbollah and other terrorist groups in the middle-east.
TRENDS IN ECONOMIC SANCTIONS AND HOW THESE AFFECT COMPLIANCE
In the last few years, the complexity and scope of economic sanctions has made sanctions compliance more difficult. Among the reasons are:
Expanded Use of Extraterritorial Sanctions. Historically, U.S. sanctions laws regulated U.S. persons, U.S.-origin products and transactions in U.S. commerce, but for the most part did not extend to conduct wholly outside U.S. commerce by non-U.S. persons. However, in the last few years, the U.S. has expanded these sanctions to assert jurisdiction extraterritorially to foreign entities that engage in certain transactions with Iran. These include:
- Expanding sanctions to restrict foreign subsidiaries of U.S. companies, in the same manner as the U.S. parent company (i.e., prohibiting virtually all transactions with Iran), and making the U.S. parent company liable for violations by the foreign subsidiary.
- Imposing sanctions on foreign banks and other financial institutions for having engaged in significant financial transactions with Iranian banks.
- Sanctioning foreign persons for engaging in significant or material transactions involving certain major Iranian industry sectors or involving certain major products (e.g., petroleum and petrochemicals).
- Specifically targeting foreign insurance companies for sanction if they insure certain voyages and/or transactions to/from Iran.
- Potentially sanctioning any person from engaging in significant or material transactions with Iranian entities identified as “Specially Designated Nationals” (SDNs), or appearing on other sanctions lists.
While very broad in scope, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) and the U.S. State Department (the principal agencies responsible for enforcing these extraterritorial sanctions) have only imposed extraterritorial sanctions on foreign parties (other than foreign banks) for egregious conduct, for example, for acting as fronting- company for Iranian shipping interests, or leasing an aircraft to an Iranian airline. In contrast, OFAC sanctions on U.S. persons or foreign banks using the U.S. banking systems have been much more vigorously enforced.
Nevertheless, the threat of sanctions being imposed extraterritorially creates a number of challenges for global businesses. Coupled with the ambiguity of the sanctions themselves, this extraterritorial reach can cause differences in interpretation about the scope of sanctions among parties to an international transaction. This, in turn, may lead to contract disputes or otherwise disrupt transactions. For example, a foreign shipper may be willing to ship toys to Iran through a container terminal in Bandar Abbas controlled by an Iranian port operator designated as a SDN. The shipper believes this is not a sanctionable activity because it does not deem the payment of routine port fees to be “significant.” Notwithstanding the shipper’s willingness, the banks through which payments will be made and the insurers covering the voyage/cargo are likely to take a much more conservative approach and be unwilling to undertake any risk of potential sanctions if a transaction involves an SDN.
Multilateral Sanctions. Unlike previous administrations, the Obama administration has, at least in principal, sought to act in concert with other countries to impose multi-lateral economic sanctions instead of a U.S. unilateral approach taken by the previous administration. Both in Iran, and in 2011 in Libya, multi-lateral sanctions initiatives have proved effective. EU sanctions, restricting the provision of insurance for many Iran-related transactions, significantly curtailed the flow of goods to and from Iran. Because sanctions laws differ from country-to-country, to ensure compliance with potentially applicable sanctions, regimes transactions often require analysis of multiple sanctions regimes.
Uncoordinated U.S. Approach to Economic Sanctions. Because U.S. sanctions are a combination of legislation, Presidential Executive Order, as well as agency rulemakings and orders, sanctions against different countries have always differed in scope depending on the policy objectives. In the past, OFAC regulations, while often vague, nonetheless provided an integrated set of regulations facilitating compliance. To the dismay of companies creating compliance policies and procedures, however, in the last three years the U.S. has adopted no fewer than four major statutes imposing additional sanctions on Iran, along with nine Presidential executive orders. The fact that this new legislation is not fully reconciled with existing statutes and regulations results in overlapping, uncoordinated sanctions laws. While reflective of the political realities in Washington, DC, where Congress and the Executive Branch do not see eye-toeye on economic sanctions issues, this complicates how companies determine the restrictions applicable to their activities. For example, the U.S. Government specifically endorses humanitarian shipments to Iran. However, depending on the facts, such shipment might fall under an OFAC general license, require an OFAC specific license, or fall within safe harbor provisions of certain extraterritorial sanctions laws .
Targeted Versus Country-Wide Sanctions. U.S. regulators have recognized the effectiveness of targeted sanctions (e.g., designating specific entities and individuals as SDNs) as compared to broad country-wide sanctions programs. Currently, U.S. economic sanctions programs for Belarus, Burma, Libya, Lebanon, Liberia, Iraq, Ivory Coast, Somalia, Yemen and Zimbabwe target specific entities, rather than bar all activity in the country. With Iran there are both broad country sanctions, as well as sanctions targeting entities under various Statutes or Executive Orders for their alleged links to proliferation of weapons of mass destruction or terrorist organizations. Due to the screening systems in place at most major banks and large companies, once a specific entity is included in the SDN or other sanctions list, it is largely cut-off from international financing, and thus largely prevented from doing business internationally. Under such circumstances, a SDN is unlikely to be able to wire funds through most banks, and thus may be deemed to default on loans or other contracts or be unable to purchase U.S.-origin goods or services. In the case of Iranian entities in particular, SDN designations had led to a game of cat-and-mouse, with designated entities forming new subsidiaries, and Iranian shipping interests reflagging and renaming vessels, transferring oil vessel-tovessel offshore and using intermediaries in third countries to launder funds to avoid sanctions. These types of deliberate and sophisticated deceptive practices make due diligence all the more important in higher risk transactions.
No Longer Just OFAC to Worry About. In addition, the interpretation and enforcement of U.S. sanctions is no longer primarily the purview just of OFAC. The U.S. State Department administers and enforces many of the extraterritorial sanctions on Iran. The U.S. Commerce Department’s Bureau of Industry and Security (BIS) is playing an ever increasing role in enforcing laws on the re-export of U.S.-origin goods to Iran, and has been aggressive in seeking to prevent the unauthorized sale or leasing of commercial aircraft, engines, and aircraft parts to Iran.
A good example of the multi-U.S. agency enforcement occurred in November 2013, when Weatherford International, a Swiss oil services company, settled potential criminal charges with the U.S. Department of Justice (DOJ) for violations of the Foreign Corrupt Practices Act (FCPA) related to payments made to gain foreign contracts and at the same time settled claims with BIS and OFAC related to the re-export of U.S.- origin goods to Cuba, Iran, Sudan and Syria. Total penalties and fines exceeded $250 million.
Similarly, the New York Department of Financial Services has begun to enforce violations of New York banking laws related to Iran sanctions, settling multi-million dollar claims with several banks and more recently focusing on foreign reinsurers that are certified under New York law.
The involvement of other U.S. federal and state agencies has dramatically increased the severity of penalties and fines. For example, in the last few years, major banks (both U.S. and foreign) have paid hundreds of millions of dollars each to settle penalty cases, with HSBC’s settlement with DOJ, the Federal Reserve, NYDFS, OFAC and FINCEN coming in at $1.92 billion.
Sanctions and SEC Disclosures. Doing business directly or indirectly with Iran or other sanctioned countries creates enhanced compliance obligations for U.S. and non-U.S. companies listed on U.S. stock exchanges. Under the Iran Threat Reduction and Syria Human Rights Act of 2012, issuers must file specific detailed reports with the U.S. Securities and Exchange Commission (SEC) if they or their affiliates engage in certain types of transactions with Iran or engage in transactions with certain Iranian entities, including the Government of Iran. Complicating matters, the SEC’s Office of Global Security Risk is increasingly active in sending queries to issuers that the SEC suspects have activities in sanctioned countries, regardless of the dollar value of the transaction. These inquiries have gained traction, because, among other things, certain state pension funds prohibit investments in companies that “do business” in Iran or in other terrorist sponsoring states and thus any business activity in such countries may be considered a material factor for investors. For public companies, this adds a layer of complexity, because even lawful or licensed transactions with Iran or other sanctioned countries may trigger SEC disclosure obligations. Whether a public company wants to engage in conduct that may trigger reporting requirements, even if lawful, is an issue that usually needs to be identified early and escalated to the general counsel’s office for resolution.
TIPS FOR AVOIDING COMPLIANCE PITFALLS
Identify and Address the Specific Risks. The complexity and changing nature of economic sanctions, both in the U.S. and abroad, means that company compliance personnel must identify and then train staff to address specific sanctions risks. The compliance procedures adopted for one business unit may make little sense to another and generic procedures and training often may be ineffectual.
Each industry has its own red flags and often the compliance team has specific examples of these red flags based on the company’s experience or published cases relevant to industry. For example, an air carrier seeking to buy or lease an aircraft engine for a type of aircraft that it does not operate would be a “red flag” for the aviation industry.
Effective Means to Flow Down Information Updates or Information on Current Sanctions. In a changing regulatory environment, employees conducting diligence and approving transactions need to have access to current information in order to accommodate changes in sanctions regimes. For example, notwithstanding that broad sanctions have largely been lifted on Burma, key compliance employees in many companies have not been made aware of this information.
Integrated Compliance. It is not uncommon for large companies to have separate manuals, training and diligence checklists covering anti-money laundering, anti-corruption and export/sanctions compliance. These companies seek to manage risk and often maintain a large and robust compliance staff. However, if the compliance function is divorced from the business function or, in other words, if the focus is not on enterprise risk management where the compliance and business functions are integrated, due diligence often becomes someone else’s job (e.g., not the job of the marketer, deal counsel, etc.). An integrated approach puts the business people and deal makers at the front line to spot irregularities. Where a company’s marketing/deal team utilizes an integrated checklist for diligence and has been trained to identify all potential “red flags” from a single list, there is a greater likelihood that sanctionable activity will be avoided. Further, if the business unit is directly involved in collecting information on counterparties for a contemplated transaction, a sense of ownership of the diligence function is created. This integrated approach ensures an effective compliance methodology. Thus, the employee organizing the transaction is the focal point for the question, “Why is payment coming from a party unrelated to the transaction?” The emphasis on risk-based compliance procedures and due diligence are areas where sanctions compliance and other compliance areas overlap. Devising a framework to analyze anti-money laundering risk, bribery/corruption (FCPA) risk and export control risk simultaneously (as evident by the Weatherford case described above where violations of FCPA and sanctions laws both came into play) can often yield a more compliant framework.
Due Diligence Pitfalls. The following are some of the diligence pitfalls we have seen in sanctions compliance:
- Equating blacklist screening to due diligence. Blacklist screening is one element of transaction diligence, but only in certain circumstances would it be the only diligence undertaken.
- Failure to Document Diligence. In the absence of documentation that diligence was done, regulators are more than likely to assume that no diligence was actually performed. This is particularly critical when clearing potential SDN matches or other red flags.
- Untimely Diligence. Compliance procedures should establish when and how often diligence needs to be updated. For example, in a company acquisition many months can pass between initial discussions/diligence and closing.
- Treating all “Red Flag” as deal killers. If a “red flag” immediately kills the deal, sales staff will be hesitant to bring such red flags to the attention of compliance staff. In fact, however, through additional diligence and other measures, red flags often can be cleared. For example, the red flag may simply be a company with a similar name to a SDN entity. Staff should understand that when compliance kills the deal, it has good reason and is acting in the best interest of the company, not merely being over reactive.
- Reliance on Contractual Representations of Foreign Entity. Obtaining a representation from the foreign buyer that it will comply with sanctions and is not a SDN does not equal due diligence, and will only be given limited weight by OFAC or other agencies in determining culpability.
Insurance, Finance, and the Penumbra Effect of Economic Sanctions. When companies engage in trade and business activities with U.S. sanctioned countries and the activities themselves are not covered by sanctions (e.g., trade in nonprohibited goods with Iran by foreign entities), they need to take into consideration other parties to the transaction whose activities are subject to sanctions, such as insurance companies and financial institutions.
For example, marine and cargo insurance policies have broad sanctions clauses that exclude or void coverage for activities that violate, may violate, or in some cases have a risk of violating applicable sanctions. Except for activities licensed by the U.S. Government, U.S. insurers and reinsurers generally cannot cover or respond to claims arising out of transactions with Iran, Cuba, Syria, or Sudan, even if the transaction was lawful for the non-U.S. insured. Further, given U.S. and EU sanctions specifically targeting the insurance sectors, insurers may deny coverage or refuse to pay a claim if they believe there is a sanctions risk.
Many major banks both inside and outside the United States have adopted risk management policies prohibiting the processing of transactions related to Iran, or otherwise permitting them to process only transactions clearly authorized by OFAC. U.S. banks routinely “hold” wire transfers in temporary suspense while they investigate potential red flags generated by their automated systems (such as a name similar to a SDN or missing information from the wire transfer). In addition, banks may “fire” customers or refuse to process transactions by third country entities identified as high risk for engaging in sanctionable transactions with Iran.
STRATEGIC PLANNING FOR CHANGE IN SANCTIONS LAWS
Your company can benefit if, instead of merely reacting to changes in sanctions laws, you plan ahead and forewarn business units of potential issues. For example, notwithstanding a grace period, a number of U.S. companies were caught offguard in 2012 when Congress removed the “foreign subsidiary exception” for Iran and imposed restrictions on the ability of foreign entities owned or controlled by U.S. parent companies to do business with Iran. Given the strong signals sent by both the Executive Branch and Congress, this U.S. Government action was a distinct possibility.
Conversely, because the U.S. uses the relaxation of sanctions as a policy tool, it might be possible to spot general trends or to predict the exact timing of relaxations. While, generally, a U.S. company cannot enter into contracts contingent on the sanctions being lifted, some companies take steps so they are strategically placed to re-enter markets should sanctions be relaxed. For example, in some cases agricultural and medical products suppliers have continued to trade with Iran – as allowed under license or safe harbor – merely to keep a footprint in Iran. However, with respect to the recent suspensions of certain sanctions on Iran, given the difficulties inherent in reaching a more permanent arrangement, U.S. Government officials are actively trying to dampen expectations that a wider relaxation of sanctions is imminent. This also likely reflects U.S. Government concerns that the current wide international support for sanctions on Iran could erode if there is a rush of major companies to Iran seeking to benefit from future relaxations of sanctions.
Because of the changing nature of economic sanctions, they can present vexing compliance issues for companies. Best practices in compliance, such as ensuring clear lines of communication coupled with tailored training and procedures will enable a company to address changes and minimize the business impact and risks of economic sanctions.
Jonathan M. Epstein is a partner at Holland & Knight LLP’s Washington, D.C. office, and focuses his practice on international trade and aviation law. Mr. Epstein’s trade practice includes advising clients in the aerospace, electronics, agrochemical, biochemical and other high-technology industries. Tom Morante is a partner at Holland & Knight LLP’s Ft. Lauderdale office, and his practice focuses on the intersection of insurance, securities, corporate, banking and tax laws in an increasingly complex global regulatory environment. Mr. Morante counsels a broad range of businesses and investors, with a focus on the financial services industry.