On June 6 and June 9, 2022, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) issued additional guidance on the sanctions that prohibit U.S. persons from making a “new investment” in Russia and from providing accounting, trust and corporate formation, and management consulting services to any person located in Russia.
Separately, from June 15, 2022, the UK Office of Financial Sanctions Implementation (“OFSI”) gained new powers to impose financial penalties for breaches of UK sanctions regulations (including, but not limited to, the UK sanctions regulations with respect to Russia) on a strict liability basis and to publish reports of cases where it is satisfied that a breach of financial sanctions has occurred but where no penalty is imposed.
This alert summarizes these new sanctions developments.
New U.S. Sanctions Developments
Guidance on the Prohibitions on “New Investment” by U.S. Persons in Russia
On June 6, 2022, OFAC issued guidance in the form of responses to new frequently asked questions (“FAQs”) to clarify certain aspects of the prohibitions on “new investment” in Russia by U.S. persons that were imposed under the following executive orders (“E.O.s”):
- E.O. 14066, issued on March 8, 2022 (prohibiting new investment by U.S. persons in the energy sector of the Russian Federation, as described in our March 10 alert);
- E.O. 14068, issued on March 11, 2022 (prohibiting new investment by U.S. persons in any sector of the Russian Federation economy as may be determined by the Secretary of the Treasury, in consultation with the Secretary of State); and
- E.O. 14071, issued on April 6, 2022 (prohibiting “all new investment in the Russian Federation by U.S. persons, wherever located” as well as “any approval, financing, facilitation, or guarantee by a U.S. person, wherever located, of a transaction by a foreign person where the transaction by that foreign person would be prohibited by E.O. 14071 if performed by a U.S. person or within the United States,” as described in our April 11 alert.
“U.S. persons” are U.S. legal entities and their non-U.S. branches; individual U.S. citizens and lawful permanent residents (“green-card” holders), no matter where located or employed; and persons present in the United States.
“New Investment” Defined
For purposes of E.O.s 14066, 14068, and 14071, OFAC defines the term “investment” as “the commitment of capital or other assets for the purpose of generating returns or appreciation.” An investment will be considered “new” if such commitment is made on or after the effective date of the respective E.O. prohibitions (March 8, March 11, and April 6 for E.O.s 14066, 14068, and 14071, respectively). New investment also includes a commitment made pursuant to the exercise of rights under an agreement entered into before the effective dates of the E.O. prohibitions, where such commitment is made on or after the effective dates of the respective E.O. prohibitions. See OFAC FAQ 1049. Importantly, as discussed below, OFAC confirmed in its new FAQ guidance that new investment does not include the maintenance of an investment made prior to the applicable effective dates (see FAQ 1050 discussed below).
OFAC considers the following transactions to constitute “new investment”:
- The purchase or acquisition of real estate in Russia, other than for noncommercial, personal use;
- Entry into an agreement requiring the commitment of capital or other assets for the establishment or expansion of projects or operations in Russia, including the formation of joint ventures or other entities in Russia;
- Entry into an agreement providing for the participation in royalties or ongoing profits in Russia;
- The lending of funds to persons located in Russia for commercial purposes, including when such funds are intended to be used to fund a new or expanded project or operation in Russia;
- The purchase of an equity interest in an entity located in Russia (see FAQs 1054 and 1055, discussed below); and
- The purchase or acquisition of rights to natural resources or exploitation thereof in Russia.
OFAC does not consider the following transactions to be “new investment”:
- Entry into, performance of, or financing of a contract, pursuant to ordinary commercial sales terms, to sell or purchase goods, services, or technology to or from an entity in Russia (e.g., a payment of an invoice for goods, where payment is made within the contracted time period and such payment does not involve participation in royalties or ongoing profits);
- Maintenance of an investment in Russia, where the investment was made prior to the effective date of the respective E.O. prohibitions, including maintenance of pre-existing entities, projects, or operations (and associated tangible property) in Russia (see FAQ 1050, discussed below); and
- Wind down or divestment of a pre-existing investment, such as a pre-existing investment in an entity, project, or operation, including any associated tangible property, located in Russia (see FAQs 1053 and 1054, discussed below).
“Maintenance” Carved out from “New Investment”
As noted, “new investment” generally excludes the maintenance of investments in Russia that were made prior to the effective dates of the respective E.O. prohibitions. OFAC clarifies in FAQ 1050 that the following transactions are “maintenance” and therefore are not prohibited:
- Transactions to ensure continuity of pre-existing projects or operations located in Russia, including payments to employees, suppliers, landlords, lenders, and partners;
- The preservation and upkeep of tangible property in Russia in which a U.S. person held an interest prior to the effective dates of the E.O. prohibitions; and
- Activities associated with maintaining pre-existing capital investments or equity investments.
“Maintenance” also includes transactions ordinarily incident to performing under an agreement established prior to the effective dates of the respective E.O. prohibitions (“pre-existing agreement”), provided that such transactions are consistent with previously established practices and support pre-existing projects and operations. However, “maintenance” does not include the expansion of pre-existing projects or operations beyond those in effect prior to the effective dates of the respective E.O. prohibitions, even if pursuant to a pre-existing agreement. “Maintenance” also does notinclude commitments pursuant to the exercise of rights under a pre-existing agreement where such commitment is made on or after the effective dates of the respective E.O. prohibitions.
Additionally, U.S. persons may modify pre-existing agreements, or enter into new agreements, provided that any transactions under such agreements are consistent with previously established practices and support pre-existing projects or operations. For example, a pre-existing agreement may be modified, or new contract established, to substitute suppliers, conduct maintenance or repairs, or comply with new environmental or safety standards. In assessing whether activity is consistent with past practice, OFAC will consider “all relevant facts and circumstances, including the transaction history between contract parties prior to the effective date of the respective E.O.s.”
Importantly, “maintenance” activities must not involve blocked persons or other prohibited transactions unless exempt or otherwise authorized by OFAC.
Export or Import of Goods, Services, or Technologies, and Related Sales or Purchases Permitted
OFAC explains in FAQ 1051 that the prohibitions on “new investment” do not extend to the export or import of goods, services, or technology, or related sales or purchases, to or from Russia, provided that such transaction is made pursuant to ordinary commercial sales terms (e.g., a payment of an invoice for goods made within the contracted time period, where such payment does not involve ongoing participation in royalties or ongoing profits). Such transactions can be supported through traditional trade finance products, including commercial letters of credit and documentary collections. Additionally, the “new investment” E.O.s do not prohibit U.S. persons from entering into new agreements for such transactions. (Such activities, however, are still subject to other export or import restrictions, including under E.O. 14068 and the U.S. Export Administration Regulations administered by the Commerce Department’s Bureau of Industry and Security. Such activities also may be subject to other relevant sanctions, including dealings in “new debt” of parties designated for Directive 1-3 sanctions under Executive Order 13662 and Directive 3 sanctions under Executive Order 14024.)
Funding of Subsidiaries and Affiliates in Russia Limited to “Maintenance”
OFAC explains in FAQ 1052 that U.S. persons can continue to fund their subsidiaries and affiliates that had projects or operations located in Russia prior to the effective dates of the respective E.O. prohibitions, but only to the extent the use of funds is consistent with “maintenance,” discussed above. Because “maintenance” does not include the expansion of pre-existing projects or operations beyond those in effect prior to the effective dates of the respective E.O. prohibitions, U.S. persons may not fund any new or expanded projects or operations by their subsidiaries and affiliates located in Russia after the effective dates of the respective E.O.s.
Transactions Relating to Divestment Permitted
OFAC explains in FAQ 1053 that transactions related to the wind down, divestment, or the facilitation of divestment of a pre-existing investment are not prohibited, provided that such facilitation is on behalf of the selling party only and does not involve a blocked party unless exempt or authorized by OFAC. For example, a U.S. financial institution may advise a client that seeks to sell an equity interest in an entity located in Russia (i.e., the seller in a divestment transaction) to a non-blocked party without running afoul of the “new investment” prohibitions. However, a U.S. person is prohibited from providing any approval, financing, facilitation, or guarantee to a non-U.S. person that seeks to acquire an equity interest in an entity located in Russia (i.e., the buyer in such a transaction).
Purchasing Debt or Equity Securities Issued by a Russian Entity Prohibited
OFAC advises in FAQ 1054 that U.S. persons are prohibited from purchasing both new and existing debt and equity securities issued by an entity in Russia. However, U.S. persons are not prohibited from selling or divesting, or facilitating the sale or divestment of, such securities to a non-U.S. person. U.S. persons also are not required to divest such securities and may continue to hold them. Additionally, OFAC has clarified that the conversion of depositary receipts to underlying local shares of non-sanctioned Russian issuers would not be considered “new investment.” The purchase of shares in a U.S. fund that contains debt or equity securities issued by entities located in Russia also would not be considered a prohibited “new investment,” provided that the Russian holdings are not the predominant share by value of debt or equity securities held by the fund.
Lending Funds to, or Purchasing Equity in, Entities Outside of Russia
OFAC explains in FAQ 1055 that U.S. persons are not prohibited from lending funds to, or purchasing an equity interest in, entities located outside of Russia, provided that “(i) such funds are not specifically intended for new projects or operations in the Russian Federation and (ii) the revenues of the entity located outside the Russian Federation are not predominantly derived from its investments in the Russian Federation.” In making such determinations, U.S. persons, including U.S. financial institutions, may “reasonably rely upon the information available to them in the ordinary course of business.”
Guidance on the Prohibitions Pursuant to E.O. 14071 on U.S. Persons Providing Accounting, Trust and Corporate Formation, and Management Consulting Services to Persons in Russia
As noted in our May 13 alert, on May 8, 2022, OFAC published a Determination Pursuant to Section 1(a)(ii) of Executive Order 14071 (“the Determination”) which prohibits “the exportation, reexportation, sale, or supply, directly or indirectly, from the United States, or by a United States person, wherever located, of accounting, trust and corporate formation, or management consulting services to any person located in the Russian Federation.” The Determination excludes (i) services to an entity located in Russia that is owned or controlled, directly or indirectly, by a U.S. person, and (ii) services in connection with the wind down or divestiture of an entity located in Russia that is not owned or controlled, directly or indirectly, by a Russian person.
As described in our May 13 alert, OFAC defines in FAQ 1034 the services subject to the Determination as follows:
“Accounting services” include “services related to the measurement, processing, and evaluation of financial data about economic entities.”
“Trust and corporate formation services” include “services related to assisting persons in forming or structuring legal persons, such as trusts and corporations; acting or arranging for other persons to act as directors, secretaries, administrative trustees, trust fiduciaries, registered agents, or nominee shareholders of legal persons; providing a registered office, business address, correspondence address, or administrative address for legal persons; and providing administrative services for trusts.”
“Management consulting services” include “services related to strategic business advice; organizational and systems planning, evaluation, and selection; development or evaluation of marketing programs or implementation; mergers, acquisitions, and organizational structure; staff augmentation and human resources policies and practices; and brand management.”
On June 9, 2022, OFAC issued guidance in the form of responses to new FAQs that address the prohibitions on activities by U.S. persons under E.O. 14071 and the Determination.
“Person Located in the Russian Federation” Defined
For the purposes of the Determination, OFAC defines “person located in the Russian Federation” as including “persons in the Russian Federation, individuals ordinarily resident in the Russian Federation, and entities incorporated or organized under the laws of the Russian Federation or any jurisdiction within the Russian Federation.” See FAQ 1058. OFAC clarifies that the Determination prohibits both the direct and indirect exportation, reexportation, sale, or supply of specified services to a person located in Russia. OFAC considers the “indirect” provision of services to include a scenario in which the benefit of the services is ultimately received by a person located in Russia.
Notably, the prohibitions in the Determination apply to services provided to a company located in the Russian Federation (a “Russian company”) by any U.S. person, including the Russian company’s U.S. subsidiary or U.S. person employees (as discussed further below). See OFAC FAQs 1061 and 1062.
OFAC confirms in FAQ 1059 that the Determination does not prohibit U.S. persons from providing services to persons located outside of Russia that have a physical presence and operations outside of Russia but that are owned or controlled by persons located in Russia, provided that the provision of services is not an indirect export to a person located in Russia.
For example, the following scenarios would not be prohibited under the Determination:
- A U.S. accounting firm provides tax advisory and preparation services to the U.S. subsidiary of a Russian company. This U.S. subsidiary has an office and employees in the United States and conducts business in the United States, and the services will not be exported or reexported to the Russian parent company.
- A U.S. management consulting firm provides strategic business advice to the subsidiary of a Russian company located in a third country. This subsidiary has an office and employees in the third country and conducts business in this third country, and the services will not be reexported to the Russian parent company.
On the other hand, the following scenarios would be prohibited under the Determination:
- A U.S. corporate service provider administers a trust established under the laws of a U.S. state, where the trust exists predominantly to hold, sell, or purchase assets on behalf of a settlor, trustor, or beneficiary who is an individual ordinarily resident in Russia.
- A U.S. corporate service provider registers a limited liability company in a third country on behalf of an individual ordinarily resident in Russia for the purpose of holding real estate assets, and this company has no other physical presence or operations in the third country.
Service by U.S. Persons on a Russian Company’s Board of Directors Not Necessarily Prohibited
OFAC advises in FAQ 1060 that the Determination does not, in and of itself, prohibit U.S. persons from serving on the board of directors of a Russian company. However, U.S. persons are prohibited from providing nominee officer or director services in which a U.S. person is contracted to serve as a nominee officer, director, shareholder, or signatory of a legal person on behalf of a person located in Russia.
Employment of U.S. Persons by a Russian Company Not Necessarily Prohibited
OFAC notes in FAQ 1061 that the Determination does not necessarily prohibit U.S. persons from working as employees of entities located in Russia. U.S. persons are prohibited, however, from providing directly or indirectly the services specified in the Determination in their capacity as employees of an entity in Russia (unless such services are provided to an entity located in Russia that is owned or controlled, directly or indirectly, by a U.S. person, or in connection with the wind down or divestiture of an entity located in Russia that is not owned or controlled, directly or indirectly, by a Russian person).
No Distinctions Between New and Existing Trusts and Companies
OFAC states in FAQ 1063 that the Determination prohibits U.S. persons from providing trust and corporate formation services to persons located in Russia, regardless of whether the services are performed as part of the formation of a new trust or company, or as part of the administration or maintenance of an existing trust or company (subject to limited exclusions discussed above for services provided to companies in Russia owned or controlled by a U.S. person or in connection with the wind down or divestiture of an entity in Russia that is not owned or controlled by a Russian person).
Executive Search and Vetting Services Prohibited
OFAC clarifies in FAQ 1064 that executive search and vetting services are prohibited “management consulting services.”
Serving as Voting Trustees Prohibited
OFAC clarifies in FAQ 1065 that the Determination prohibits U.S. persons from serving as voting trustees on behalf of, or for shares of, persons located in Russia, unless otherwise exempt or authorized by OFAC.
Educational Services Not Prohibited
OFAC notes in FAQ 1066 that the Determination does not prohibit “the provision of educational services, such as online university courses, on the subjects of accounting, management consulting, or trust and corporate formation to persons located in the Russian Federation.” The provision of such services, however, must not evade or avoid the prohibition on providing the underlying services to persons located in Russia.
Exporting, Reexporting, Selling, or Supplying Software Related to Accounting, Management Consulting, or Trust/Corporate Formation Not Necessarily Prohibited
OFAC explains in FAQ 1067 that the Determination does not itself prohibit U.S. persons from exporting, reexporting, selling, or supplying, directly or indirectly, software related to accounting, management consulting, or trust and corporate formation to persons located in Russia (subject to applicable export controls). The Determination also does not prohibit U.S. persons from “providing services associated with the export of such software, such as software design and engineering,” so long as such services do not fall within the categories of management consulting, accounting, or trust and corporate formation, defined above and by OFAC in FAQ 1034.
The following scenario provided by OFAC would not be prohibited under the Determination:
- A U.S. software company signs a contract with a Russian company for design, engineering, licensing, and delivery of software that the Russian company uses to perform its internal accounting. As part of the contract, the U.S. company provides continuing updates and technical support services related to the software (setting up new users, troubleshooting errors, etc.).
On the other hand, OFAC indicates the following scenario would be prohibited:
- A U.S. management consulting company signs a contract with a Russian company to assist the Russian company in selecting a new enterprise application software. This contract includes assessing the needs of the Russian company, providing a list of possible software choices to the company, and providing continuing advisory services on the implementation and use of the software to optimize the Russian company’s profits.
Tax Preparation and Filing Services Prohibited
OFAC provides in FAQ 1068 that tax preparation and filing services to any person in the Russian Federation are prohibited “accounting services” (subject to the exclusions discussed above for services provided to companies in Russia owned or controlled by a U.S. person or in connection with the wind down or divestiture of an entity in Russia that is not owned or controlled by a Russian person). However, the Determination does not prohibit the export, reexport, sale, or supply, directly or indirectly, of tax preparation-related software to Russia (subject to applicable export controls). See FAQ 1067.
New UK Sanctions Developments
OFSI’s Enforcement Powers: Financial Penalties
On June 8, 2022, OFSI published updated guidance on “enforcement and monetary penalties for breaches of financial sanctions” (the “OFSI Guidance”). The updated OFSI Guidance reflects changes to the UK sanctions enforcement framework introduced by the UK Economic Crime Act 2022 in March (see previous alert), which came into force on June 15, 2022. These changes apply with respect to all cases where a potential breach occurred on or after June 15, 2022; cases relating to breaches that occurred prior to this date will continue to be assessed with respect to the rules and guidance that were in place at the time.
Under the new rules, OFSI may impose—on a strict liability basis—civil financial penalties of up to a maximum of (i) £1,000,000 or (ii) 50% of the estimated value of the funds or resources to which the breach relates (whichever is greater). While pre-existing legislation provided for penalties of those amounts, under the changed rules, OFSI will no longer be required to demonstrate that a person had “knowledge or reasonable cause to suspect they were in breach of a financial sanction” at the time of the breach. The OFSI Guidance confirms that “the legal standard for HM Treasury to impose a monetary penalty” may be met even where a “mistake” causes a breach.
OFSI’s Director, Giles Thomson, indicated in a blog post that the updated OFSI Guidance “does not represent a change to OFSI’s overall enforcement approach” and stated that the new powers do “not mean that OFSI will impose a monetary penalty in every case we find there to be a breach of sanctions.” Further, the same blog post also reiterated that factors such as due diligence measures that firms take to prevent breaches will continue to be taken into account by OFSI when it makes decisions concerning possible enforcement action.
This change to strict liability alongside consideration of aggravating and mitigating factors brings UK sanctions enforcement into closer alignment with the U.S. rules under OFAC’s Economic Sanctions Enforcement Guidelines. The OFSI Guidance sets out, similar to the OFAC guidelines, a list of factors that OFSI will consider when deciding whether or not to impose a monetary penalty, including: whether there has been intentional circumvention of sanctions; the value of the breach; the risk of harm to the sanctions regime’s intention arising from the breach; level of knowledge of breach; overall behaviour of the party, including repeat offending or systems and control failure; whether there has been a breach of an OFSI license or a failure to apply for a license; whether a voluntary disclosure was made; and the public interest.
Review of Monetary Penalties
The updated OFSI Guidance also addresses the change to OFSI’s review process for financial penalties, which has been amended so that reviews requested (following the imposition of a financial penalty by OFSI) after June 15, 2022, may now be undertaken by a Minister or “senior official” at HM Treasury, rather than a Minister as was required previously. In his blog post, Mr. Thomson explained that this change will allow HM Treasury to “more effectively manage the resourcing implications of this work” and that the change does not alter the rights of persons subject to a financial penalty by OFSI to seek review.
Publication of Case Summaries in Cases of Breaches Where No Financial Penalty Is Imposed
OFSI has also obtained, as a result of the Economic Crime Act, the power to publish information concerning breaches of UK sanctions regulations where no monetary penalty has been imposed. According to the updated OFSI Guidance, OFSI may publish the following details with respect to any such breach case where this is in the public interest:
- who performed the breach;
- a factual summary, including: the type of breach; sanctions regime under which the breach has occurred and regulation broken; and whether a voluntary disclosure was made with respect to the breach;
- the aggregated GBP value of the transactions to which the breach relates;
- why OFSI decided to publish a case summary;
- any compliance lessons OFSI wishes to highlight to assist others to avoid a similar breach; and
- any other information “required to give a true understanding of the case and OFSI’s consideration of it.”
OFSI’s Director said this would help to “deter future non-compliance” and confirmed that any persons in relation to whom OFSI intended to publish such an update would be notified prior to publication and given an opportunity to make representations to OFSI ahead of publication.
Increase in OFSI’s Resources
On June 9, 2022, the UK Government provided its response to a report by the House of Commons Treasury Committee published on March 23, 2022, in relation to the sanctions package that the UK introduced with respect to Russia following the invasion of Ukraine (the “Government Response”). The Government Response, which is authored by HM Treasury, addresses various points raised in the original report, including a recommendation that the Government “consider increasing [OFSI’s] resources without delay and to provide surge capacity in the form of staff with appropriate expertise.”
The Government Response commits to ensuring that “appropriate resources are in place to ensure our sanctions regime is effective” and confirms HM Treasury has “reprioritised work and resources to provide additional support” to OFSI. Significantly, the Government Response also reports that additional permanent staff are being recruited to OFSI and that it is expected to “at least double in size over financial year 2022/23.” According to figures published by HM Treasury in July 2021, as of March 2021 OFSI had 37.8 full time equivalent staff.
It remains to be seen how these changes to OFSI’s powers and resources will alter UK sanctions enforcement over the coming months and years, but taken together they arguably represent the most significant development in OFSI’s capabilities since it was established in 2016.