The UK Office of Financial Sanctions Implementation (OFSI) is expected to issue regulations in April 2017 introducing a civil penalties framework for violations of financial sanctions. See our previous advisory and blog post, and draft guidance issued by OFSI in December 2016. This measure will mark a significant change to the existing UK sanctions framework, which provides for criminal liability only, and will orient UK sanctions enforcement more towards the type of civil sanctions regime administered by the US Department of Treasury, Office of Foreign Assets Control (OFAC). This figures to significantly impact the UK sanctions enforcement landscape.
Section 146 of the Policing and Crime Act 2017 (the Act), enacted in January 2017, authorizes Her Majesty’s (HM) Treasury to impose civil penalties for sanctions violations of up to the greater of £1 million or 50% of the value of the transaction at issue. This is significant in several respects, including:
- Civil liability. The civil penalties regime will be the first of its kind for sanctions violations in the United Kingdom. Previously, violators were subject to criminal liability only.
- Standard of proof. In order for a person to be held liable for a civil violation, HM Treasury must conclude that “on the balance of probabilities,” the person committed a violation of financial sanctions regulations. This is equivalent to the US standard of “preponderance of the evidence.” Notably, this is a significantly more relaxed standard than the UK criminal standard, which requires proof of guilt beyond a reasonable doubt.
- Magnitude of penalty. As discussed in more detail below, the £1 million penalty figure far exceeds the maximum OFAC penalty, and could potentially clear the way for very large penalties of a magnitude unseen in the UK sanctions context to date. As a point of reference, in recent years, the United States has seen nine- and ten-figure sanctions settlements in cases involving allegedly egregious conduct, including several enforcement actions targeting the European financial industry. The United Kingdom, as a global financial center, could adopt a similar enforcement posture.
Additionally, under sections 144 and 145 of the Act, criminal sentences for sanctions violations have been increased on summary conviction from six months to 12 months, and on conviction on indictment from two years to seven years.
Types of Activities Covered
Notably, the Act focuses only on financial sanctions. In this regard, it is useful to explain the UK distinction between financial and trade sanctions, a distinction that does not really exist in US sanctions law.
The Act defines “financial sanctions legislation” as, inter alia, legislation providing for measures that:
Impose prohibitions or obligations for one or more of the following purposes—
(i) freezing funds or economic resources;
(ii) preventing funds or economic resources being made available; [or]
(iii) prohibiting or restricting access to financial markets or financial services.
The term refers also to freezing orders issued under the Anti-terrorism, Crime and Security Act 2001 and directives to cease business with designated persons under the Counter-Terrorism Act 2008.
Therefore, the Act’s civil penalties are applicable to dealings with listed persons and entities owned or controlled by listed persons. As a threshold matter, this clearly includes entities designated for asset freezing and prohibitions against the provision of funds or economic resources.
Significantly, the Act appears to go farther than that, covering the restrictions on capital markets access that are a linchpin of the EU/UK-Russia sanctions program. Under those sanctions, EU persons are prohibited from dealing in, or providing investment services related to, certain transferable securities and money-market instruments issued by designated Russian financial institutions, defense companies, and energy companies. See our previous advisory. These restrictions would appear to be included within the ambit of measures that “prohibit or restrict access to financial markets or financial services” as set out in the definition above, and therefore would be “financial sanctions” subject to civil enforcement by OFSI.
Notably, the term “financial sanctions” does not include trade sanctions such as restrictions on exports to a targeted country. For example, the Act does not provide for civil penalties for violations of the EU/UK export restrictions targeting the Russian energy industry, or the remaining trade sanctions in effect with respect to Iran. This is a key difference between the UK sanctions regime and the US regime, which does not distinguish between financial and trade sanctions for penalty purposes.
State of Mind Requirement
The Act provides that a person is subject to civil liability for violating financial sanctions where the person knows, or has “reasonable cause to suspect,” that the person is in breach. OFSI has provided the following guidance regarding the “reasonable cause to suspect” standard:
“Reasonable cause to suspect” is a higher standard. It covers situations where the relevant person does not have clear confirmation of an event, but they are aware of something that can prompt them to think it may have happened. It does not cover merely the theoretical possibility that an event might have happened.
This is in sharp contrast to most US sanctions programs, which are strict liability regimes, meaning that OFAC need not conclude that a person acted with any particular state of mind in order to hold a person civilly liable.
Applicability to Officers
The Act provides at Section 148 that an “officer” of a company civilly penalized for a financial sanctions violation can himself or herself be penalized where HM Treasury is satisfied, on the balance of probabilities, that the company’s violation:
(a) took place with the consent or connivance of the officer, or (b) was attributable to neglect on the part of the officer.
“Officer” is defined to include directors, managers, secretaries, and partners.
This could represent a potentially significant risk for individual officers in the sanctions enforcement context, especially considering that the Act subjects officers to liability for negligence.
Deferred Prosecution Agreements
Section 150 of the Act provides that entities can enter into deferred prosecution agreements (DPAs) with prosecutors regarding potential violations of financial sanctions. Specifically, the Act amends the Crime and Courts Act 2013 to add financial sanctions violations to the list of offenses for which entities may enter into DPAs, which provide for suspension of enforcement by the Crown Prosecution Service and/or the Serious Fraud Office in exchange for the entity agreeing to certain conditions. Notably, DPAs have been available under the UK Bribery Act since 2014. See our previous advisory.
This marks another move towards US-style sanctions enforcement. DPAs have been a key feature of US sanctions enforcement in the criminal context for several years.
Serious Crime Prevention Orders
Section 151 of the Act designates a financial sanctions violation as a “serious crime” for purposes of the Serious Crime Act 2007, thereby authorizing the issuance of serious crime prevention orders (SCPOs) with respect to such activity. An SCPO is a civil injunction issued by a court that restrains a person’s involvement in “serious crime” as defined under the Serious Crime Act 2007.
Requirement of a “UK Nexus”
OFSI has provided the following draft guidance regarding its sanctions jurisdiction:
To come within our enforcement of sanctions, there has to be a UK connection. The breach does not have to occur within UK borders – a “UK nexus” could be created by such things as a UK company working overseas, an international transaction clearing or transiting through the UK, action by a local subsidiary of a UK parent company, or financial products or insurance bought on UK markets but held or used overseas. We will consider the facts to see whether they come within our authority.
For the most part, this is similar to the jurisdictional reach of US sanctions regulations, which apply to the actions of all US persons worldwide, including those occurring outside the United States, and strictly (and occasionally creatively) control transactions clearing or transiting the US financial system.
The reference to “action by a local subsidiary of a UK parent company,” however, is of particular interest. EU sanctions do not purport to apply to non-EU subsidiaries of EU companies, and UK sanctions – both those implementing EU sanctions and those issued by the United Kingdom itself – generally provide that they apply only to UK persons, which does not include non-UK subsidiaries of UK entities. Additionally, it is worth noting that US sanctions programs, other than the Cuba and Iran programs, generally do not apply to non-US subsidiaries of US companies. So any move towards applying sanctions to a local subsidiary, even on a case-by-case basis as described in the OFSI guidance above, would be notable. The OFSI guidance seems to suggest that the subsidiary’s activities, in order to trigger sanctions, would somehow have to touch the United Kingdom, perhaps through the support of the parent company or involvement by UK person individuals. In any event, caution in this area is warranted.
OFSI Guidance / Aggravating & Mitigating Factors / Penalty Matrix
The December 2016 draft OFSI guidance sets out a detailed explanation of which aggravating and mitigating factors OFSI will consider in assessing a civil penalty. Specifically, OFSI will consider the following factors:
- Whether there was a direct provision of funds or economic resources to a designated person
- Whether there was a circumvention of sanctions
- The severity of the violation, including the GBP value of the transaction and the harm done to the sanctions program’s objectives
- Whether a company’s knowledge of the law and compliance standards were consistent with established standards in the company’s industry
- Whether the violation was deliberate, involved a failure to take reasonable care, or involved failure of controls or inadequate legal representation
- Whether the activity involved the breach of license conditions
- Whether a professional (such as an attorney) was involved in facilitating unlawful behavior
- Whether there were repeated violations
- Whether there was a voluntary disclosure
- Whether it is in the public interest to pursue enforcement in a particular case
Regarding voluntary disclosure in particular, OFSI stated in its draft guidance that it will regard the failure to voluntarily disclose a violation as an aggravating factor. Where a person does submit a disclosure, it must be materially complete and made in good faith.
Furthermore, in its draft guidance, OFSI set out a matrix specifying how it will impose penalties. First, OFSI will determine the base penalty applicable to the violation by determining the statutory maximum penalty, then assessing what penalty within that maximum is reasonable and proportionate. Next, OFSI may downwardly adjust the base penalty based on certain mitigating factors. Specifically, OFSI will reduce the penalty by up to 50% if there is a voluntary disclosure in a “serious” case; by up to 30% if there is a voluntary disclosure in a “most serious” case; and by up to 15% if there is no voluntary disclosure, but the case is not assessed as “most serious.”
Notably, the proposed OFSI matrix is similar to the matrix set out in OFAC’s enforcement guidelines, as set out in a 2008 interim rule (which contains the matrix) and a 2009 final rule (which refers to the 2008 interim rule and matrix). See our previous advisory.
Comparison with OFAC Sanctions
The new civil enforcement framework for UK sanctions closely resembles the system that OFAC administers, and very well may set the United Kingdom on a path to US-style sanctions enforcement. Similar to the US approach to sanctions, there is an agency within HM Treasury (OFSI) specifically responsible for sanctions enforcement; statutory authorization for large civil penalties; and draft OFSI guidance providing for aggravating and mitigating factors that are similar to those set out in OFAC guidance.
However, there remain key differences between the UK and US civil enforcement regimes:
- Financial vs. trade sanctions. The UK civil enforcement program focuses on financial sanctions only, while the US system does not distinguish between financial and trade sanctions. This may reflect significant substantive differences between UK and US sanctions, with US sanctions featuring far stricter and export and reexport controls in the sanctions context. This was evident, for example, in the recent US enforcement action against ZTE. See our previous advisory.
- State of mind requirement. The UK civil sanctions regime provides for liability only where a person has “reasonable cause to suspect” that a violation took place, while the US regime provides for strict liability. This is a significant difference in legal standards, although practically speaking, this may not materially impact how a UK company would develop a sanctions compliance policy as compared to a US company.
- Magnitude of penalty. The UK maximum penalty is at once higher and lower than its US counterpart. The specified GBP maximum is £1 million, which is nearly quadruple the specified dollar maximum $289,238 (as periodically adjusted for inflation) under most OFAC sanctions programs. However, with regard to penalties tied to the value of the transaction, the UK maximum is 50% of the value of the transaction, while the US maximum is twice the value of the transaction.
Of course, even with a robust civil sanctions framework in place, the great wild card will be the frequency and intensity of OFSI enforcement. Over the last decade or so, OFAC enforcement actions – in particular those targeting European financial institutions – have made worldwide headlines, with occasional nine- and ten-figure settlements sending shockwaves through industries engaged in trade (both lawful and otherwise) with sanctioned countries. The Bush and Obama Administrations made sanctions enforcement a key aspect of US national security and foreign policy, and the Trump Administration’s approach has been consistent with this to date. With the new civil sanctions program coming into effect, it will be for the UK government to decide just what role sanctions enforcement should play as a tool of UK foreign policy. As a global financial center, the United Kingdom may continue to orient its enforcement posture towards the US position.