On August 10, President Obama signed into law the Iran Threat Reduction and Syria Human Rights Act of 2012 (Act). The new law significantly broadens the extraterritorial scope of existing U.S. sanctions for Iran-related activities by expanding the types of activities subject to sanctions, supplementing the list of available sanctions, and prescribing numerous measures designed to isolate Iran further from the international financial community.

Two provisions of the law in particular may affect U.S. public companies and foreign private issuers and their affiliates. First, the Act extends the prohibitions on trade with Iran, which previously have applied to U.S. entities and their foreign branches, to include foreign entities that are “owned or controlled” by U.S. persons. Second, the Act creates a new disclosure obligation under

Section 13(a) of the Exchange Act that requires issuers subject to the periodic reporting provisions of that section to disclose in their reports whether they or their affiliates have “knowingly engaged” in sanctionable activity involving Iran.

The new disclosure obligations will be effective for quarterly and annual reports filed after February 6, 2013 by issuers with a class of securities registered under

Section 12 of the Exchange Act, which includes issuers with securities listed on a national securities exchange. Although the obligations are not subject to SEC rulemaking, the SEC may adopt clarifying rules pursuant to its general rulemaking authority under Section 13(a) of the Exchange Act.

The new law can be viewed here.

Foreign subsidiaries no longer may conduct prohibited Iran-related activities

Section 218 of the Act eliminates the loophole in prior statutes under which foreign subsidiaries of U.S. companies could conduct trade activity with Iran if the activity did not involve U.S. persons or was not otherwise supported, facilitated, or approved by the U.S. parent company. The Act provides that non-U.S. entities (partnerships, associations, trusts, joint ventures, corporations, or other organizations) “owned or controlled” by a U.S. person may not “knowingly” engage in a transaction, directly or indirectly, with the Government of Iran, or with a person subject to the jurisdiction of the Government of Iran, that would be prohibited if the transaction were engaged in by a U.S. person or in the United States.

The Act defines “own or control” to mean any of the following:

  • To hold more than 50 per cent of the equity interest by vote or value in an entity;
  • To hold a majority of seats of the board of directors of an entity; or
  • To otherwise control the actions, policies, or personnel decisions of an entity.  

In this context, Section 218 essentially applies the same level of prohibitions to foreign subsidiaries and other owned or controlled entities that currently exists under U.S. sanctions against Cuba, which also apply to entities “owned or controlled” by U.S. persons.

Violations of this law are subject to civil penalties applied against a U.S. parent company that owns or controls the non-U.S. entity of up to $250,000 or twice the value of the illicit transaction. A strict reading of the Act’s language suggests that no penalty would apply if no single U.S. entity meets the “owns or controls” test, even if U.S. entities in the aggregate own or control the non-U.S. entity. Companies for which this distinction may be important should seek guidance from the Office of Foreign Assets Control of the U.S. Treasury Department.

The Act contains a grace period for companies whose current organizational structure or operations would violate Section 218 by providing that such a company may avoid civil penalties by divesting or terminating business with an offending entity by February 6, 2013. There are no criminal penalties for violations of Section 218.

The Section 218 prohibitions are to be implemented by President Obama by October 9, 2012.

The practical effect of the new law is that U.S. companies with subsidiaries in Europe or other non-U.S. jurisdictions that have conducted business in Iran or with sanctioned entities no longer will be able to take a “hands-off” approach to management of those subsidiaries’ activities. Even though the activities by the subsidiaries may be permitted by the laws of their home countries, U.S. law now will prohibit those activities and will authorize enforcement through the imposition of penalties against the U.S. parent company.

Disclosure of violations of Iran sanctions required in Exchange Act reports

Section 219 of the new law amends Section 13(a) of the Exchange Act to provide that companies required to file annual and quarterly reports under Section 13(a), including foreign private issuers, must disclose in the reports whether the reporting company or any “affiliate” has “knowingly engaged” in sanctionable activity, which includes activity relating to:

  • The Iranian petroleum industry or the development of weapons of mass destruction or other military capabilities, as described in Section 5(a) or (b) of the Iran Sanctions Act of 1996;
  • Financial institutions that facilitate development of weapons of mass destruction, terrorism, money laundering, and other violations, as described in Section 104(c)(2) or (d)(1) of the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA);
  • The transfer of weapons and technology used in human rights abuses, as described in CISADA Section 105A(b)(2);
  • Transactions with persons whose property is blocked pursuant to executive orders regarding terrorism or weapons of mass destruction; or
  • Transactions with the Government of Iran, or any entity owned or controlled by the Government of Iran or acting on its behalf, without specific authorization from the U.S. government.  

Although U.S. companies currently may be complying with U.S. sanctions applicable to Iran, those companies would be required by the new law to report activity of their affiliates if the activity relates to the foregoing matters. The Act does not define the term “affiliate,” but if the term is given the meaning ascribed to it in SEC rules, the new reporting obligation could encompass sanctionable activity undertaken by controlling persons of the issuer (potentially directors, certain officers, and large shareholders) and persons under common control with the issuer.

The disclosure of sanctionable activity in the issuer’s quarterly or annual report will have to include a “detailed description of each such activity,” including:

  • The nature and extent of the activity;
  • The gross revenue and net profit, if any, attributable to the activity; and
  • Whether the issuer or its affiliate intends to continue the activity.  

If a company discloses in a quarterly or annual report that it or an affiliate has knowingly engaged in sanctionable activity, the company will be obligated to “file” with the SEC, concurrently with the filing of the annual or quarterly report, a separate “notice” stating that the required disclosure has been included in the report. Upon receipt of the notice, the SEC will be required to transmit the company’s report to the President, the Committee on Foreign Affairs and the Committee on Financial Services of the House of Representatives, and the Committee on Foreign Relations and the Committee on Banking, Housing and Urban Affairs of the Senate, and to make available on the SEC’s website the information contained in the company’s report and notice. The President must initiate an investigation and determine within 180 days if sanctions should be imposed on the company or its affiliate.

Although the Act does not impose new penalties associated with the disclosures required under Section 219, companies will be subject to liabilities under Section 18 of the Exchange Act for incomplete or misleading disclosures.

Conclusion

The new law not only closes a loophole previously available to foreign subsidiaries of U.S. companies to engage in sanctionable activity, but also increases the reputational and disclosure risks associated with this activity. By imposing new SEC disclosure requirements regarding sanctionable activity engaged in by affiliates of an issuer, the law imposes a due diligence burden that may be significant to some companies. The Act reinforces the need for effective internal compliance measures both to prevent prohibited activity involving Iran and to ensure compliance with the new obligation to report any such activity.