On August 13, 2014, the Office of Foreign Assets Control (“OFAC”) of the U.S. Department of the Treasury released revised guidance regarding its so-called “50 Percent Rule,” which generally states that entities owned 50 percent or more by persons blocked pursuant to OFAC regulations or Executive Order are themselves blocked. While the statement mostly clarifies existing policy, it does make a few important changes and includes helpful guidance in the form of Frequently Asked Questions. Most notably, the revised guidance makes clear that the 50 Percent Rule applies to entities owned 50 percent or more in the aggregate by one or more blocked persons.
OFAC’s revised guidance highlights the need for parties engaging in international investment and business transactions, and particularly in high-risk areas, to establish detailed diligence processes to ensure that they have a clear understanding of the direct and indirect parties with which they are dealing, as well as their ownership structure.
The 50 Percent Rule
When the U.S. government designates blocked persons by Executive Order or otherwise places such individuals and entities on OFAC’s Specially Designated Nationals List (“SDN List”), it blocks their property and interests in property that come into the United States or the possession or control of a U.S. person. As a result of such blocking, U.S. persons may not engage in transactions with blocked persons, unless authorized by OFAC. In addition, blocked persons are considered to have an interest in any entity in which they own a 50 percent or greater interest. Therefore, these 50 percent-owned entities are themselves considered blocked, even if they are not specifically included on the SDN List. As a result, U.S. persons also may not engage in transactions with entities in which blocked persons own 50 percent or more, unless authorized by OFAC.
While the 50 Percent Rule applies to ownership only, and not control, companies also should exercise caution in dealing with non-blocked entities that are controlled by blocked persons because such non- blocked entities could be designated in the future and there is otherwise a risk of indirectly dealing with the blocked persons controlling such non-blocked entities.
The Revised Guidance
The revised guidance and FAQs expand upon earlier guidance issued by OFAC by setting forth new interpretations of the 50 Percent Rule. While the revised guidance does not impose new requirements or designate new individuals or entities to be blocked, there are certain key implications to consider in light of the revised guidance.
- Aggregation: An entity is considered blocked if it is owned 50 percent or more in the aggregate by one or more blocked persons. For example, an entity that is owned 25 percent by one blocked person and 25 percent by another blocked person is considered a blocked person because of the 50 percent aggregate ownership. Note that for this analysis, the owners may be blocked by designation on the SDN List or implicitly blocked as a result of the 50 Percent Rule. Prior to the issuance of the revised guidance, the holdings of blocked persons in an entity were not aggregated for purposes of the 50 Percent Rule.
- Indirect Ownership: If one or more blocked persons own shares aggregating 50 percent or more of an entity through intermediary entities and the intermediary entities are 50 percent or more owned in the aggregate by blocked persons, the subsidiary is considered a blocked person, as are the intermediary entities. However, if a blocked person owns 25 percent of two entities and each of those entities own 50 percent of a third entity, that third entity is not considered a blocked person. The guidance highlights the need for look-through diligence to assess the ultimate ownership and consider whether the 50 percent threshold is crossed in the aggregate.
- Divestment: If one or more blocked persons divest their ownership stake in an entity that was owned 50 percent or more by blocked persons such that the entity is no longer owned 50 percent or more by blocked persons, it is possible that the entity will no longer be considered blocked. If such divestment occurs entirely outside the United States and does not involve U.S. persons, the entity is no longer considered a blocked person following the divestment. However, if the property of the entity came within the United States or in the possession or control of a U.S. person and was blocked prior to the divestment, the entity is still considered blocked because OFAC disregards any subsequent transactions. The property will only be unblocked if and when OFAC (i) authorizes dealings in the property or (ii) removes blocked persons from the SDN List such that the entity is no longer owned 50 percent or more by blocked persons. Determining whether a blocked person remains so following a divestment requires careful due diligence.
- Sectoral Sanctions List: The 50 Percent Rule, including the revised guidance, also applies to entities on the Sectoral Sanctions Identification List (“SSI List”) created in July 2014 in the Ukraine-related sanctions program. However, because the SSI List restricts certain financing transactions but does not block any persons, entities 50 percent or more owned by SSI-listed persons are subject to the same restrictions but not to blocking.
The revised guidance makes clear that diligence regarding direct and indirect counterparties is critical to ensuring compliance with U.S. economic sanctions laws and regulations. Moreover, diligence must go beyond screening parties against the SDN List, because under the 50 Percent Rule, certain entities are implicitly considered blocked even though they are not explicitly listed on the SDN List. Implementation of policies, procedures, and related training will help operating companies, investment funds, and asset managers understand which persons may be blocked to ensure compliance. OFAC’s guidance affirms that government regulators expect companies to identify and consider – through tailored policies and procedures – all direct and indirect counterparties, as well as their ownership and control relationships.