The Iran Threat Reduction and Syria Human Rights Act (the "Threat Reduction Act"), enacted on August 10, 2012, imposes new liabilities on U.S. companies for the activities of foreign entities that they own or control. Additionally, the Threat Reduction Act separately requires disclosure of contracts, transactions and "dealings" with Iranian and other foreign entities by companies that are required to file annual or quarterly reports under Section 13(a) of the Securities and Exchange Act of 1934 (the "Exchange Act"). These disclosures will be required in Form 10-Ks (or Form 20-Fs for foreign private issuers) and Form 10-Qs that are due after February 6, 2013. See our alerts "New Iran Sanctions Legislation: Tighter Restrictions on Indirect Dealings and Enhanced Reporting Obligations" and "Key Year-End Considerations for Public Companies" for an overview of the substantive provisions of the Threat Reduction Act.

This Alert focuses on the new Exchange Act reporting requirements, addresses some of the key issues that reporting companies face as a result of the new reporting requirements, and identifies distinctions between the sanctions measures in Section 218 of the Threat Reduction Act ("Section 218") and the new Exchange Act reporting requirements in Section 13(r) of the Exchange Act ("Section 13(r)"), which was added by Section 219 of the Threat Reduction Act.

What Are the New Sanctions Measures in Section 218?

Prior to the Threat Reduction Act, U.S. sanctions on Iran did not fully reach foreign entities owned or controlled by U.S. companies. For example, a foreign subsidiary, even one that was wholly owned by a U.S. parent company, could permissibly engage in certain Iran-related transactions that would be prohibited if performed by the U.S. parent company. Under Section 218, however, after February 6, 2013, if a foreign entity owned or controlled by a U.S. person engages in transactions that would be a violation of U.S. laws and regulations if it were performed by a U.S. person, then the U.S. person is subject to civil liability for the acts of the foreign entity that it owns or controls.

Ownership or Control Defined

Under Section 218, civil sanctions liability derives from an entity established or maintained outside the U.S. that is owned or controlled by a U.S. person, where ownership or control is defined as holding more than 50 percent of the equity interest by vote or value in an entity, holding a majority of seats on the board of directors of an entity, or otherwise controlling the actions, policies, or personnel decisions of an entity.

Safe Harbor from Liability

Section 218 provides that a U.S. person will not be subject to civil liability for the sanctionable activities of a foreign entity owned or controlled by it if the U.S. person divests or terminates business with the foreign entity within 180 days after enactment of the Threat Reduction Act, which works out to be February 6, 2013. It is unclear, however, whether the safe harbor also reaches situations where the foreign entity terminates covered transactions, but the U.S. person does not affirmatively break its connection to the owned or controlled foreign entity through divestment or termination. It should also be noted that the Threat Reduction Act does not contain a contract sanctity provision, or any other means to grandfather existing contracts.

What Are the New SEC Reporting Requirements Under Section 13(r)?

Section 219 added new Section 13(r) to the Exchange Act, which requires an Exchange Act reporting company (including both U.S. issuers and non-U.S. issuers) to disclose certain Iran-related activities and transactions or dealings with certain "blocked persons" knowingly engaged in by the company or any of its affiliates. The Securities and Exchange Commission (the "SEC") is not required to adopt rules in order to implement the provisions under Section 13(r); the reporting requirements automatically take effect with respect to annual and quarterly reports due after February 6, 2013.

On December 4, 2012, the staff of the SEC's Division of Corporation Finance published compliance and disclosure interpretations (the "C&DIs") related to the new disclosure requirements. According to the C&DIs, the disclosures will be required without regard to the actual filing dates of the Exchange Act reports. Even if an issuer files its report before February 6, 2013, the disclosure requirements apply if the due date of the report is after February 6, 2013.

Affiliate Defined

In the C&DIs, the SEC staff confirmed that the term "affiliate" in Section 13(r) is defined in Exchange Act Rule 12b-2. An "affiliate" of, or a person "affiliated" with, an issuer, is defined as a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the issuer. "Control" is defined under Exchange Act Rule 12b-2 to mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise.

Reportable Activities

Disclosure is required if an issuer or any of its affiliates knowingly engaged in any of the covered activities during the period covered by the report. Under Section 14(12) of the Iran Sanctions Act of 1996 (the "ISA"), the term "knowingly", with respect to conduct, a circumstance, or a result, means that a person has actual knowledge or should have known of the conduct, circumstance, or result. The Exchange Act standard for knowledge is comparable.

The following activities and transactions are required to be disclosed under Section 13(r):

  • Activities described in section 5(a) or 5(b) of the ISA, which include transactions in which an entity provides goods, services, technology, or support that could contribute to the development of Iranian production of petroleum, petrochemical products, refined petroleum products, or related infrastructure; participation in a joint venture with the Government of Iran or another entity if the venture would permit Iran to receive technology or equipment that would contribute to the development of Iranian petroleum resources; transporting Iranian crude oil or assisting Iran in evading sanctions; or exporting or transferring any goods, services, technology, or other items that would contribute to Iran's ability to acquire or develop weapons of mass destruction or advanced conventional weapons.
  • Activities described in Section 104(c)(2) or 104(d)(1) of the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 ("CISADA"), which include transactions relating to financing the Government of Iran's acquisition of weapons of mass destruction or facilitating terrorist activities, facilitating the activities of a person subject to financial sanctions pursuant to UN Security Council Resolutions that impose sanctions with respect to Iran, including Central Bank of Iran or other Iranian financial institutions, and engaging in transactions with, or that benefit, Iran's Islamic Revolutionary Guard Corps.
  • Activities described in Section 105A(b)(2) of the CISADA, which include transfer of technology or services to Iran that are likely to be used for human rights abuse against the Iranian people.
  • Transactions or dealings with persons who are designated by the U.S. government as blocked persons for their involvement with terrorism or weapons of mass destruction and transactions with the Government of Iran, its delegates, or entities owned or controlled by it.

Required Disclosure

If an issuer or any of its affiliates knowingly engaged in any of the covered activities, the issuer must provide a detailed description of the activity in its annual or quarterly report, including the nature and extent of the activity, the gross revenues and net profits attributable to the activity, and whether or not it or its affiliate intends to continue the activity.

In addition, concurrently with the filing of the annual or quarterly report, the issuer is required to file with the SEC a notice that identifies the issuer and indicates that disclosure of the activity has been included in its periodic report. On December 19, 2012, the SEC's Division of Corporation Finance announced that issuers should submit these notices through EDGAR on a new form type called IRANNOTICE. The notices will appear with the issuers' filing history on EDGAR and will be searchable. The new EDGAR form type is expected to be available for use on January 14, 2013.

Is There a Safe Harbor under the Exchange Act Reporting Requirements?

No. February 6, 2013 marks the beginning of the sanctions liability under Section 218, which allows U.S. companies a six-month period to divest or terminate business. The sanctions safe harbor, however, does not carry over to the Exchange Act reporting obligations, even though the reporting obligations also begin with reports required to be filed with the SEC after February 6, 2013. Because these reports cover the period for the fiscal year (for Form 10-Ks or 20-Fs) or the fiscal quarter (for Form 10-Qs), reportable activities that occurred during 2012 (for calendar year issuers) or the last fiscal quarter in 2012 (for non-calendar year issuers) must be disclosed. In the C&DIs, the SEC staff confirmed this understanding. Therefore, the annual report for the year ended December 31, 2012 must disclose all reportable activities that took place between January 1, 2012 and December 31, 2012, regardless whether the activity took place before the Threat Reduction Act went into effect or was otherwise lawful when conducted.

Section 13(r) requires the President to initiate investigations if a covered activity is disclosed in an annual or quarterly report pursuant to Section 13(r). However, Section 218 and Section 4 of Executive Order 13628 provide for a "safe harbor" to the acts of entities owned or controlled by a U.S. person prior to February 6, 2013. Until February 6, 2013, then, there may possibly be transactions that do not trigger civil liability under Section 218, but which may trigger Section 13(r) reporting and mandatory Presidential investigation requirements.

Must All Acts that Might Subject a Company to Section 218 Sanctions Liability Be Reported to the SEC?

No. Generally, the constellation of acts that could subject a company to Section 218 sanctions is different from those that trigger SEC reporting obligations under Section 13(r). These distinctions can be complex.

Section 218 subjects a U.S. person to civil penalties, as set forth in Section 206(b) of the International Emergency Economic Powers Act ("IEEPA") for the actions of foreign entities owned or controlled by the U.S. person, if the activity would violate IEEPA if done by a U.S. person, or from the United States. By contrast, Section 13(r) applies to activities described under specific sections of the ISA, CISADA, dealings with "blocked persons" designated pursuant to certain Executive Orders, and dealings with the "Government of Iran" without specific authorization from the appropriate Federal department or agency. According to the C&DIs, "specific authorization from the appropriate Federal department or agency" refers to both general licenses and specific licenses issued by Office of Foreign Assets Control of the Department of Treasury. A transaction or dealing authorized by a foreign government must still be disclosed, although the issuer may choose to include the foreign authorization in its disclosures.

Do the New SEC Reporting Requirements Apply to Activities or Persons That Are Not Subject to Section 218 Sanctions Liability?

Yes, potentially, and this is a potential trap for the unwary. Section 218 applies only to an entity that is "owned or controlled" by a U.S. person. A foreign entity is "owned or controlled" by a U.S. person if the U.S. person holds more than 50 percent of the equity interest by vote or value in the entity, holds a majority of seats on the board of directors of the entity, or otherwise controls the actions, policies, or personnel decisions of the entity.

Section 13(r) applies to U.S. and non-U.S. reporting issuers with respect to the activities by the issuers and their affiliates. The definition of "affiliate" and "control" under the federal securities law is broader than that used under Section 218. An affiliate could be a company or joint venture in which a public company owns a less-than majority interest. It could also potentially include a company that has a board member representing the interest of the public company. Determination of affiliate status and control is based on the specific facts and circumstances on a case by case basis. Factors that should be taken into consideration generally include ownership of voting stock, board representation, shareholder rights (including veto rights), and relationships of the parties.

Unlike the sanctions provisions, as written, the disclosure requirements would apply to activities of significant shareholders, directors or officers of the issuer who are deemed to control the company, activities of companies under common control with the issuer, as well as activities of subsidiaries and certain joint ventures and portfolio companies. Some of these potential "affiliates" may or may not cooperate, drawing into question whether they satisfy the definition of affiliate.

What Questions Should a Reporting Company Ask Itself?

A reporting company should ask the following questions to determine whether any disclosure is required in its next annual or quarterly report:

  • Who are its foreign affiliates or domestic affiliates that have foreign operations?
  • Which of these affiliates engaged in activities during 2012 (for calendar year issuers) or during the fourth quarter of 2012 (for non-calendar year issuers) that would subject the issuer to the reporting requirements under Section 13(r)?
  • What are the necessary compliance procedures in light of the new requirements?
  • In addition, if any of the affiliates engages or engaged in sanctionable or reportable activities, what can it do to avoid sanctions liability?

What Should a Reporting Company Do to Identify Reportable Activities?

In light of the new Section 13(r), a company should implement one or more of the following steps to identify reportable activities and make sure it complies with the new requirements:

  • Designate a responsible person in the company with responsibility for compliance with the new requirements. This person should be charged with overseeing compliance with the reporting requirements, implementing procedures that are reasonably designed to enable the company to comply, maintaining necessary records and answering questions.
  • Inform appropriate employees worldwide of the new reporting and sanctions laws and require them to report activities potentially subject to disclosure or sanctions.
  • Review its existing contracts and consider whether to run a search of the counterparties to the contracts or payments against the Specially Designated Nationals and Blocked Persons List maintained by Office of Foreign Assets Control of The Department of the Treasury to identify parties that are designated as a global terrorist, proliferator of weapons of mass destruction or the Government of Iran.
  • Supplement the director and officer questionnaire with additional questions that help to identify the reportable activities.
  • Put compliance policies in place to prevent the participation in the sanctionable activities by its affiliates, especially those outside the U.S.
  • Establish control and disclosure procedures to detect and identify reportable activities so that the company can demonstrate that it has taken reasonable efforts to comply with the requirements.

What Should a Reporting Company Do After a Reportable Activity Is Identified?

After a reporting company identifies a reportable activity by itself or any of its affiliates, it may take one or a combination of the following approaches:

First, the issuer must disclose the reportable activities in the next annual or quarterly report and file a separate notice with the SEC in accordance with the provisions of Section 13(r). With respect to a disclosed activity, a Presidential investigation may be initiated and might result in the imposition of sanctions.

Second, the issuer should assess potential civil liability under Section 218 to identify foreign entities that it owns or controls and the activities of those entities that could subject it to Section 218 civil liability. With respect to the specific sanctionable activities, the issuer should research the related jurisdictional reach of the U.S. sanctions laws and regulations with the advice of its counsel.

Third, the issuer may divest its ownership or control of the affiliate, or require the entity to terminate the activities prior to February 6, 2013 to avoid civil liability under Section 218. In addition, Section 13(r) requires an issuer to disclose whether the issuer or its affiliate intends to continue the activity.

Fourth, if the issuer is unable to obtain all the information required for the disclosure, the issuer may include a statement that it has taken reasonable steps to collect the required information but is unable to do so because of lack of real control of the foreign affiliates.

Conclusion

Companies should act quickly. Reporting companies will be subject to sanctions liability and SEC reporting obligations for the acts of their affiliates, starting from February 6, 2013. Potential risk is especially acute for those reporting companies with foreign affiliates that are involved in energy transactions in the Middle East, or private equity firms with foreign portfolio companies. Regardless, reporting companies should conduct risk-based internal investigations to determine whether any affiliate engages in any reportable activities. Investigation should be followed by appropriate actions to eliminate connections that subject the reporting companies to sanctions liability or SEC reporting obligations, including steps to proactively consult U.S. regulators where breaking foreign affiliates' Iran connections may be impossible to accomplish by February 6, 2013.