On December 31, 2011, the President signed into law H.R. 1540, the "National Defense Authorization Act for Fiscal Year 2102" (NDAA or the Act). Included within the Act is Section 1245 which calls for the imposition of sanctions on the financial sector of Iran. Based on the language of Section 1245 and the President's signing statement,  expressly reserved presidential foreign affairs powers allocated under the Constitution, there remains a range of potential new sanctions targeting the Iranian financial sector and those financial institutions that conduct business with Iran. Short of explicit guidance from the Departments of State and Treasury clarifying (1) the scope of what is required by section 1245; (2) where the Executive Branch maintains flexibility to appropriately tailor any additional sanctions; and (3) how those sanctions could affect licensed or exempt transactions with Iran, it appears that U.S. and third-country financial institutions will continue to withdraw from even licensed or exempt transactions relating to exports of goods or services to Iran. This trend appears to be hastened by rumors that a second round of new sanctions proposed under H.R. 1905 (the Iran Threat Reduction Act of 2011) are already in effect (they have passed the House of Representatives but not the Senate-and have not been signed into law).
Section 1245 of the NDAA is the result of long-standing conflict between (1) Congressional desire to implement additional sanctions on the Government of Iran and third-country entities engaged in business with Iran and (2) the Executive Branch's reluctance to target third-country entities for sanctions and its intent to preserve foreign policy flexibility. In 1996, Congress passed the Iran Libya Sanctions Act  to force the Executive Branch to impose sanctions on any person making investments that "directly and significantly contribute to the enhancement of Iran's ability to develop petroleum resources of Iran." While the Executive Branch initiated some investigations under ISA and Treasury's Office of Foreign Assets Control (OFAC) imposed additional sanctions on persons in Iran, Congress was not satisfied and, in 2010, passed the Comprehensive Iran Sanctions Accountability and Divestment Act (CISADA). CISADA amended the Iran Sanctions Act to expand U.S. sanctions against third-country entities; codified existing sanctions on Iran; created new tools through which to impose additional sanctions on Iran; and created additional due diligence obligations for certain U.S. industries (including the U.S. financial sector). As a result of CISADA, OFAC published the Iranian Financial Sanctions Regulations, 31 C.F.R. Part 561, and OFAC's sister agency, the Financial Crimes Enforcement Network (FinCEN), published a Notice of Proposed Rule Making identifying Iran as a jurisdiction of money laundering concern and proposing the imposition of special measures on the Iranian banking sector.  Despite the imposition of additional sanctions on third-country entities,  persons in Iran  and the promulgation of these regulations, Congress remains dissatisfied. As a result of the November 2011 International Atomic Energy Report  identifying Iran's progress in developing nuclear weapons and heightened tensions between Iran and Europe and the United States, various members of Congress drafted legislation calling for additional sanctions on Iran. Section 1245 was added as an amendment to the NDAA and, despite opposition from the Executive Branch and other prominent business groups, was signed into law as initially drafted.
New Sanctions under Section 1245
Section 1245(b) of the NDAA designates the entire financial sector of Iran, including both private and government-owned banks, as being of "primary money laundering concern," which reiterates the designations made by FinCEN in November. Section 1245(c) freezes the assets and interests in property of all Iranian financial institutions that come within the possession or control of U.S. persons. It is unclear whether this section would require the blocking of payments for exports of exempt or licensed goods to Iran, since OFAC's definition of property interest is expansive.  It appears that Treasury and State are reviewing the potential effects of this section on payments for licensed and exempt transactions. Until the Executive branch clarifies its positions, we expect financial institutions will remain wary of even licensed or exempt transactions.
Section 1245(d)(1)(A) prohibits the opening of a correspondent or payable-through account by any foreign financial institution, that "has knowingly conducted or facilitated any significant financial transaction with the Central Bank of Iran or [any other Iranian financial institution]." Existing correspondent and payable-through accounts must either be closed or subjected to strict, but unspecified, conditions. The prohibition applies equally to all non-U.S. financial institutions, regardless of whether they are owned or controlled by private investors or governments. Section 1245(d)(4)(D), however, softens the prohibition, somewhat, by providing that the prohibitions in Section 1245(d)(1)(A) apply to a non-U.S. bank controlled by a non-U.S. government only to the extent of the bank's "financial transaction[s] for the sale or purchase of petroleum or petroleum products to or from Iran conducted or facilitated [more than] 180 days after [the NDAA's enactment]."
Thus both private and government-controlled foreign banks, including central banks, will be subject to sanctions for their "significant financial transactions" with Iranian banks, including Iran's central bank. Although the phrase "significant financial transactions" has not been defined, we expect the transaction levels in the Iran Sanctions Act or Executive Order 13590 could be used as reference points. In addition, the Iranian Financial Sanctions Regulations, 31 C.F.R. Part 561, identify the following factors as relevant to whether a transaction is "significant": the size, number and frequency of the transactions; the nature of the transactions; whether management was aware of or participated in the transactions; the proximity of the foreign financial institution to the blocked party; and the impact of the transactions on the objectives of U.S. sanctions. See 31 CFR 561.404.
For non-U.S., non-Iranian banks controlled by governments, penalties will only be assessed regarding petroleum-related transactions. Privately owned non-U.S. banks must be denied new correspondent or payable-through accounts, and their existing accounts must be either closed, or subjected to "strict conditions" in the President's discretion, starting 60 days after the effective date of the NDAA.  For privately controlled banks, any significant financial transactions with Iranian financial institutions, even if unrelated to petroleum, refined petroleum or petrochemicals, would expose the bank to denial of U.S. correspondent accounts.
Although section 1245(d)(4) authorizes the President to waive sanctions under certain conditions, we are not currently in a position to speculate on the probability of such a waiver. In summary, both private and government-controlled non-U.S. financial institutions are subject to U.S. sanctions under the NDAA and are therefore likely to be exceptionally cautious about Iran-related financial transactions until the Executive branch clarifies its position on the scope of the NDAA's prohibitions.
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Ultimately, without explicit guidance from the Departments of Treasury and State, it appears that licensed and exempt transactions between the United States and Iran-part of the "smart sanctions" targeting the Government of Iran but not the people of Iran-will become the collateral damage of increased tensions between Iran and the United States.