On August 16, 2010, the US Department of the Treasury, Office of Foreign Assets Control (OFAC), published as a final rule the Iran Financial Sanctions Regulations (IFSR), 75 Fed. Reg. 49,836, which impose new conditions and prohibitions targeting non-US financial institutions that conduct business or transactions with the Government of Iran (GOI); certain Iranian persons, entities, and organizations; and other persons engaging in specified activities regarding Iran. Section 104 of the Comprehensive Iran Sanctions, Accountability, and Divestment Act (CISADA), Pub. L. 111-195, enacted on July 1, 2010 provides statutory authority for the IFSR, as we noted in our previous advisory. The IFSR can be found at 31 C.F.R. Part 561, and are effective as of August 16, 2010. OFAC will be accepting public comments regarding the IFSR until October 10, 2010.
Activities Triggering Possible Sanctions
Under § 561.201(a) of the IFSR, OFAC can prohibit or impose strict conditions on opening or maintaining a foreign financial institution’s “correspondent account” or “payable-through account” at a US financial institution if the Secretary of the Treasury finds by order or regulation that the foreign financial institution knowingly (i.e., with knowledge or reason to know) has engaged in any of the following specified activities:
- Facilitating efforts of the GOI (including efforts of Iran’s Islamic Revolutionary Guard Corps (IRGC) or any of its agents or affiliates) in (i) acquiring or developing weapons of mass destruction (WMD) or WMD delivery systems, or (ii) providing support to foreign terrorist organizations or international acts of terrorism.
- Facilitating activities by any person designated under any United Nations Security Council Resolution regarding Iranian proliferation efforts. (We note that it is unclear whether the designated persons will be listed on the Specially Designated Nationals (SDN) list published by OFAC or only in the annexes to the relevant United Nations Security Council Resolutions.)
- Engaging in money laundering to carry out any activities in 1 or 2.
- Facilitating efforts by the Central Bank of Iran or any other Iranian financial institution to carry out any activities in 1 or 2.
- Facilitating a “significant transaction or transactions” or “significant financial services” for (a) the IRGC or its agents whose property or interests in property is blocked under the International Emergency Economic Powers Act (IEEPA), or (b) any financial institutions whose property or property interests are blocked under IEEPA but only if in connection with Iranian WMD proliferation or support for terrorism on or after August 16, 2010.
Sanctions That Can Be Imposed
If OFAC determines that a foreign financial institution has engaged in any of the five types of activity summarized above, OFAC has discretion to impose different types of sanctions with regard to that foreign financial institution. These sanctions can vary from strict conditions for continuing to do business with US financial institutions, to precluding correspondent and payable through accounts with US financial institutions.
1. Strict Conditions on Foreign Financial Institutions
Under § 561.201(b), OFAC may impose strict conditions on a correspondent or payable-through account opened or maintained by a US financial institution for a foreign financial institution that OFAC determines has engaged in the above conduct. The conditions that can be imposed include, but are not limited to:
- Prohibiting trade financing through the foreign financial institution’s account(s);
- Restricting the types of transactions that may be undertaken through the account(s), such as limiting them to personal remittances;
- Imposing monetary limits on the transactions that may be processed through the account(s); or
- Requiring approval from the US institution for all transactions through the account(s).
If OFAC imposes one or more conditions under this section, it appears that OFAC will not take the further step (discussed below) of barring accounts with US financial institutions. The conditions are effective when the US financial institution receives actual or constructive notice of imposed conditions.
2. Prohibitions on Foreign Financial Institutions
Pursuant to § 561.201(c), OFAC also may prohibit a US financial institution from opening or maintaining a correspondent or payable-through account for a foreign financial institution determined to have engaged in activities under § 561.201(a). The names of such foreign institutions will be listed in Appendix A to 31 C.F.R. Part 561, to be released and updated in the future.
Under § 561.504, US financial institutions cannot open a new correspondent or payable-through account for a foreign financial institution that is designated by Appendix A. Such a prohibition becomes effective on the earlier of the date the US financial institution receives either actual or constructive knowledge of the prohibition. For existing correspondent or payable-through accounts of persons who are designated by Appendix A under the IFSR, US financial institutions will have a 10-day period from the date they receive actual or constructive knowledge of the prohibition to:
- Process transactions to close the account; and
- Transfer the funds remaining in the account to an account outside of the United States of the foreign financial institution, after which the US account must be closed.
If any transactions beyond these two types need to be processed, or if transactions occur after the 10 day period, the US financial institution must apply for a specific license from OFAC and receive authorization before proceeding. The IFSR do not describe OFAC’s policy for granting such authorizations. It appears that funds remaining in the accounts after the 10-day period has closed essentially will be treated as “blocked” property unless and until OFAC authorization to move the funds has been granted.
The IFSR do not stipulate criteria by which the Secretary of the Treasury can decide whether to impose strict conditions on the foreign financial institution’s account(s) under § 561.201(b) or prohibit the opening or maintenance of any applicable account(s) altogether under § 561.201(c). It appears OFAC has broad discretion to make these determinations. The IFSR do not provide a formal mechanism by which such determinations may be appealed, but it may be possible for a foreign financial institution to challenge its designation under established procedures set forth at 31 C.F.R. §501.807.
Prohibitions on Persons Owned or Controlled by U.S. Financial Institutions
Section 561.202 prohibits “persons” who are “owned or controlled” by US financial institutions from knowingly engaging in any transaction with or benefiting the IRGC or its “agents” whose property is blocked under IEEPA, as specifically identified on the SDN List, e.g., [NPWMD] [IRGC].
The IFSR do not define what “owned or controlled” means for purposes of this section. As a general matter, we believe that exercising control as a parent company over subsidiaries or affiliates should be considered in functional terms, such as the ability to exercise certain powers over important matters affecting an entity. It is possible that OFAC could view “own or control” as holding a 50 percent or greater interest.
Important Definitions and Interpretations
The IFSR define certain key phrases in the new regulations, which can significantly affect the scope and implementation of the rule. We discuss some of the most important definitions and interpretations below, which were not defined by the CISADA.
- Under § 561.308, foreign financial institution means any foreign entity that is engaged in the business of accepting deposits, making, granting, transferring, holding, or brokering loans or credits, or purchasing or selling foreign exchange, securities, commodity futures or options, or procuring purchasers and sellers thereof, as principal or agent. It includes but is not limited to depository institutions, banks, savings banks, money service businesses, trust companies, securities brokers and dealers, commodity futures and options brokers and dealers, forward contract and foreign exchange merchants, securities and commodities exchanges, clearing corporations, investment companies, employee benefit plans, and holding companies, affiliates, or subsidiaries of any of the foregoing.
- Under § 561.309, US financial institution is defined almost identically to foreign financial institutions. However, we note that US financial institutions includes “insurance companies,” while insurance companies are not explicitly included within the definition of foreign financial institution. This term includes branches, offices, and agencies of foreign financial institutions that are located in the United States.
- Under § 561.313, financial services includes loans, transfers, accounts, insurance, investments, securities, guarantees, foreign exchange, letters of credit, and commodity futures or options. It is not clear whether OFAC intends for this list of activities to be exhaustive. It would seem the term “includes” and OFAC’s general approach to illustrative rather than complete sets of examples make it unlikely that the list is exhaustive.
- Under § 561.403, for purposes of § 561.201, facilitate refers to the “provision of assistance” by a foreign financial institution, and includes, but is not limited to, the provision of currency, financial instruments, securities, or any other transmission of value; purchasing; selling; transporting; swapping; brokering; financing; approving; guaranteeing; or the provision of other services of any kind; or the provision of personnel; or the provision of software, technology, or goods of any kind. This broad definition is not exhaustive of the types of activities that may involve facilitation by foreign financial institutions, and other activities also may be covered.
“Significant” Transactions and Financial Services
As defined by § 561.403, for the purposes of determining which transactions and financial services are “significant” with respect to assistance to the IRGC, its agents, or SDN financial institutions, OFAC may consider the “totality of the facts and circumstances.” OFAC may consider some or all of the following factors:
(a) the size, frequency and number of transactions, e.g., whether the transactions or financial services are increasing or decreasing over time, and the rate of increase or decrease;
(b) the nature, type, complexity and purpose of the transaction or service;
(c) the level of awareness and pattern of conduct, e.g., whether the transaction(s) or financial service(s) are (1) performed with the involvement or approval of management or only by clerical personnel; and (2) part of a pattern of conduct or the result of a business development strategy;
(d) the nexus or proximity between the transaction participant and a blocked person, e.g., a direct customer relationship generally would be of greater significance than an indirect or tertiary relationship;
(e) the impact of the transaction or service based on the goals of CISADA, e.g., contribution to SDN economic benefit, WMD proliferation and delivery capacity, international terrorism, or suppression of human rights, as opposed to supporting humanitarian activities or the payment of basic or extraordinary expenses authorized under UNSCR 1737;
(f) the use of deceptive practices, e.g., attempts to obscure or conceal the actual parties or true nature of the transaction(s) or financial service(s); and
(g) other relevant criteria as OFAC may deem relevant on a case-by-case basis.
The rule does not specify whether certain factors are more important or less important for OFAC’s analysis. Although some factors listed are accompanied by a reference to aggravating or mitigating factors, not all of the factors do so.
Section 561.701 provides for civil penalties not to exceed $250,000 or twice the amount of the transaction at issue and for criminal penalties of up to $1 million and/or imprisonment for up to 20 years for “any person” who violates, attempts to violate, conspires to violate, or “causes a violation” of the prohibitions in sections 561.201(b) and (c) described above. The regulations also provide for such penalties to be levied on a US financial institution if a person “owned or controlled” by such an institution violates a prohibition in §561.202 of the regulations and the US financial institution “knew or should have known” that the person engaged in a violation of the prohibition. Section 561.702 provides detailed pre-penalty notice and settlement procedures for civil violations, and references OFAC’s standard procedure found at 31 C.F.R. 501, Appendix A.
The new sanctions regulations as proposed represent another significant increase in the pressure placed on non-US persons (i.e., foreign financial institutions) to limit their involvement in the Iranian economy. Through various means - including aggressive enforcement actions by OFAC, BIS and other US law enforcement authorities, SEC inquiries, additional multilateral and national sanctions measures, and the new US sanctions legislation and regulations implementing the same - the risk profile for non-US persons and entities conducting business with Iran is increasing. A comprehensive understanding of the legal landscape inside and outside the United States is a necessity. As for the newly proposed IFSR, the types of foreign financial institutions and service providers potentially subject to the risk of sanctions is very broad. Given the types of conduct that can trigger sanctions, foreign financial institutions must be particularly diligent in understanding the activities of customers involved in Iran, as well as their own direct Iranian activities, including by monitoring the listing by OFAC of Iranian entities and individuals that are the target of these sanctions. Furthermore, the expanded definition of "facilitation" (which is written more broadly than in other US sanctions regimes) increases the risk of triggering sanctions. The one possibly ameliorating factor is that in order for sanctions to be imposed, the Treasury Department must specifically identify the foreign financial institution engaged in sanctionable conduct, which may mean that such institutions may receive some advance notice or warning of conduct that can be curtailed to avoid sanctions.