OFAC Issues Regulations Implementing Recent Iran Sanctions Legislation

With the passage of the Comprehensive Iran Sanctions, Accountability and Divestment Act of 2010 (the CISAD), the United States has ratcheted up economic sanctions against Iran. In this round of sanctions the U.S. is not acting alone. The European Union (EU) and individual countries also have enacted significant sanctions implementing a recent UN Security Council (UNSC) Resolution on Iran. These newly-minted sanctions are already having a significant effect as companies seeking to comply with the new sanctions are curtailing activities relating to Iran.

Complying with the new Iran sanctions laws (notably CISAD) presents practical challenges. Not only are the laws complex, but they present a moving target for compliance as regulations and guidance are promulgated and new Iranian entities are designated. In particular, on August 16, 2010, the U.S. Treasury Department Office of Foreign Assets Control (OFAC) issued a rule implementing one section of CISAD governing both U.S. and foreign financial institutions. This alert lays out a practical approach to compliance under these new sanctions laws. In particular, companies must look beyond the “black letter” legal analysis in preparing a plan of action for how to address compliance.

CISAD Overview

President Obama signed CISAD into law on July 1, 2010. CISAD expands U.S. sanctions against Iran by creating a variety of new sanctions that may be imposed on companies (including wholly-foreign companies) that engage in transactions with certain Iranian entities or involving certain Iranian industries. The following is a description of some of the key provisions of CISAD.

Sanctions for Foreign Financial Institutions

CISAD § 104 has enormous implications for U.S. and foreign banks and applies to certain other financial institutions as well. Modeled after anti-money laundering statutes, this provision requires U.S. financial institutions to police the foreign financial institutions with which they do business. The recent rule issued by OFAC now gives guidance on how this provision of CISAD will be implemented and enforced.

• If OFAC determines that a foreign bank or other foreign financial institution engages in transactions that support Iran’s development of weapons of mass destruction or other sanctionable activity, or more generally provide significant financial services to the Iran Revolutionary Guard Corps (IRGC) and its subsidiaries, or certain designated Iranian banks, then OFAC will impose restrictions on the foreign banks’ ability to maintain or transact through U.S. banking correspondent and payable-through accounts.
• A U.S. bank or other U.S. financial institution is liable for activities of its foreign subsidiaries subject to this provision, if the U.S. financial institution knew or should have known of such activities. A U.S. bank would also be subject to penalties if it allowed a designated foreign financial institution to open or maintain correspondent accounts in violation of an OFAC designation order.

The U.S. General Accountability Office submitted a written report for a congressional subcommittee hearing in late July 2010 (GAO Report) identifying by name 44 foreign banks providing correspondent services to Iranian banks designated by the U.S., and 18 U.S. banks that do business with those foreign banks that service designated Iranian banks. OFAC did not immediately designate any foreign banks in conjunction with the new rule. Whether this is due to internal clearance processes or whether OFAC is allowing a grace period to give banks an opportunity to come into compliance is unclear.

Expanded Sanctions Relating to Petroleum Resources

CISAD § 102 requires the U.S. government to investigate and impose at least three sanctions from an expanded list of sanctions against companies that:

• invest $20 million or more (or a series of investments of $5 million or more up to $20 million over 12 months) that enhance Iran’s ability to develop petroleum resources (e.g., crude oil or natural gas development)
• provide goods, services, technology or other support that could facilitate the maintenance or expansion of Iran’s domestic production of refined petroleum products in excess of $1 million (or $5 million over the course of 12 months) (e.g., construction, modernization or repair of Iranian petroleum refineries)
• sell refined petroleum products (e.g., gasoline, diesel, etc.) or provide goods, services, technology, or other support that contributes to Iran’s ability to import refined petroleum products in excess of $1 million (or $5 million over the course of 12 months) (e.g., providing insurance, financing, or shipping services related to the import of gasoline into Iran)

It is likely that the President has or will delegate enforcement of Section 102 to the State Department, which administered the prior law that this section amends. Unlike the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC), which publishes regulations and secondary guidance material regarding its sanctions programs, historically the State Department has not issued regulations or guidance. This means that there may be no readily available answers to key concerns for foreign companies, such as whether and how waivers will be applied.

The recent GAO Report identified 41 foreign firms having commercial activity in the Iranian gas and petrochemical sector, not including four major international oil companies that announced they will not undertake new activity in Iran.

Other Significant Provisions

• Import/Export From the U.S. CISAD closes certain exceptions that allowed the import of luxury items such as rugs from Iran. Interestingly, CISAD does not close the so-called “inventory exception,” under which foreign companies, under some circumstances, may re-export uncontrolled U.S.-origin goods (which includes foreign made goods that contain more than de minimus U.S. content) to Iran. Earlier versions of CISAD had proposed to remove this exception.
• Procurement Blacklist. CISAD requires the U.S. government to bar from participation in the U.S. government procurement process any entity that sells “sensitive technology” to Iran. Although regulations have not been issued yet, this will likely mean that U.S. prime contractors cannot subcontract for goods or services from such a barred entity in support of U.S. government contracts. The GAO Report identified seven foreign firms by name that have both U.S. government contracts and engage in petroleum sector activity in Iran.
• Divestment. CISAD encourages state and local governments to divest from companies that invest in Iran by creating a “safe harbor” to protect the divestiture from being challenged under federal securities and other laws. According to press reports, in recent years 20 U.S. states have divested their pension funds from companies that do business with Iran.
• Countries That Allow Diversion. CISAD puts additional pressure on certain Gulf states and other countries that are seen as conduits for sales of certain restricted goods and services. It does this by requiring the U.S. government to restrict exports of certain types of goods, services and technologies to countries that are identified as conduits for such diversion to Iran.

CISAD expands sanctionable activity and increases potential sanctions from the prior Iran Sanctions Act of 1996 (1996 Act). The 1996 Act essentially has not been enforced against foreign companies, in part because (i) the EU threatened to take action in the WTO in 1998 after an attempt by the U.S. to apply the Act against EU companies, and (ii) the 1996 Act gave the President considerable discretion regarding whether or not to enforce the law. Congress sought in CISAD to expand sanctions well beyond the 1996 Act, and to force the President to investigate and seek sanctions against foreign companies by limiting the President’s discretion and ability to seek waivers.

International Sanctions on Iran

Unlike previous U.S. attempts to impose unilateral sanctions, in this case significant sanctions are being imposed multilaterally, including strong sanctions from the EU.

UN Security Council Resolution (UNSCR) 1929

President Obama had pushed for broad UN sanctions targeting in particular Iran’s ability to import gasoline and refined petroleum. The inclusion of the compromise language in UNSCR 1929 in June 2010 made passage of CISAD a certainty. This UN Resolution seeks to curtail Iran’s ability to obtain weapons and to continue to develop its nuclear capabilities. While historically these UNSC Resolutions have had limited effect, and notwithstanding the compromise language in UNSCR 1929, this Resolution has given the United States, the EU and other countries additional justification to impose stringent sanctions on Iran.

EU Sanctions

On July 26, 2010, the European Union adopted sanctions implementing UNSCR 1929, which are in some respects broader than CISAD. Some of the major provisions of these sanctions include prohibitions on:

• the export of certain goods and technology (both military and dual-use) to Iran
• the sale, financing, or supply of key equipment, technology, or related services relating to oil and natural gas refining, exploration, or extraction to Iran or any Iranian-owned entity (including the use of member state aircraft or vessels for such supply)
• any new investment or loans related to the Iranian oil or gas industry
• provision of insurance or reinsurance to any entity in Iran and entities outside of Iran controlled by Iranian entities
• Iran air carriers from making cargo flights to/from EU countries

Unlike CISAD, EU sanctions do appear to apply extraterritorially to non-EU entities outside the EU, although there are not minimum transaction thresholds for petroleum-related sanctions as found in CISAD. In addition, the sanctions require blocking of assets of the IRGC, Islamic Republic of Iran Shipping Lines (IRISL) and other entities associated with Iran’s attempt to develop nuclear weapons. The sanctions also severely restrict Iran’s access to banking and financial services, as EU banks are now subject to notification and/or advance government approval for transfers of funds over certain amounts to or from Iran.

How Should Companies Address Compliance With Sanctions Laws?

For companies that are grappling with how to address the new Iran sanctions laws, the specifics may differ depending on whether the company is U.S. or foreign and the nature of their business, but there are some commonalities in how to approach these issues, both in terms of external and internal actions, as follows:

1. Legal Analysis of Sanctions. A first step must be to understand the “black letter” legal implications of CISAD and its implementing regulations. Given the complexity of CISAD and the interplay between CISAD and pre-existing regulations and policies, it is advisable that such advice come from experienced trade counsel. Two important points in that legal analysis under CISAD should be:

• Parent Liability. Under CISAD, a parent company may now be sanctioned for the activity of its subsidiary companies, if the parent knows or should have known of such activity. Under pre-existing OFAC regulations, the activities of a foreign subsidiary of a U.S. parent company did not create a violation for the U.S. parent, unless the parent facilitated that activity.
• Violations of the Iran Sanctions Act of 1996 (1996 Act). Generally, CISAD does not apply retroactively, and in many cases does not apply to activities commenced prior to its enactment. However, CISAD mandates that the U.S. immediately investigate companies that may have been operating in violation of the 1996 Act (e.g., investments of $20 million or more in the petroleum sector), thus giving enforcement teeth to a law that many had considered largely irrelevant prior to CISAD’s passage. Recent testimony by U.S. government officials indicates that the U.S. government is reconsidering certain cases under the 1996 Act that predate the Obama Administration.

2. Consider Non-”Black Letter” Factors. There are a number of non-legal or pragmatic factors that should be considered. Some of these factors are:

• Industry and Business Partner Actions. The reaction to CISAD by some industries, such as shipping and insurance, have been dramatic over a short time period. Such reactions by business partners (e.g., denial of insurance coverage or cancellation of shipping contracts for certain activities) may make impracticable the continuation of activities related to Iran but not covered under CISAD.
• Transaction Minefield. The designations of major Iranian banks and the likely rapid pace of future designations of IRGC-related entities as Specially Designated Nationals (SDNs), as well as the new EU bank transactions reporting requirements, further isolate Iran and raise risk factors even for transactions that do not appear subject to the sanctions.
• U.S. Nexus. While no U.S. nexus is required for the U.S. to impose sanctions on a foreign company, such nexus can and has been used to pressure foreign companies to divest from Iran. For example, foreign companies that are publically traded may be required to report as “material” virtually any activity in Iran. In addition, anecdotally, the U.S. appears to be taking into account a foreign company’s contacts in Iran when assessing whether or not to allow a foreign company to acquire a U.S. company under the Committee on Foreign Investment in the United States (CFIUS) process.

Note: Even in the absence of substantial U.S. nexus, the U.S. can and has designated entities for failure to comply with extraterritorial aspects of U.S. law. The effects of “blacklisting” can be devastating for a foreign company.

3. Develop Plan of Action. With an understanding of both the legal and practical factors, a company can develop and implement a plan of action and milestones for achieving such plan. A company’s bona fide plan to wind-up sanctionable activities may be sufficient under CISAD to avoid being sanctioned by the U.S. The plan should include:

• an audit of the company’s activities and business relationships to determine what activities are sanctionable or could put the company at risk
• an initial determination and plan of action to continue, terminate or wind down existing contracts and activities related to Iran or specific entities
• a revision of internal contracting procedures including “know your customer” guidance to reflect the new sanctions laws

Since these sanctions are in their initial stages of implementation, companies need to be flexible and prepare for possible changes based on regulations or guidance as they are promulgated. Hence, decision makers should be briefed that external actions and internal policies will likely need to be re-examined and adjusted.

Conclusion

The imposition of such broad multilateral sanctions by the United States, the EU and other countries will test the effectiveness of economic sanctions as a means of achieving policy goals. Certainly, initial indications are that the sanctions are having an immediate affect. They raise difficult questions that require not only sound legal advice but also a broad consideration of all factors in determining what steps need to be taken to comply with the new laws and mitigate risk.