OFAC Issues Guidance On Iranian Sanctions Set Forth In Section 12456 Of 2012 National Defense Authorization Act - Export Controls & Trade & Investment Sanctions

On February 14, 2012, the Treasury Department, Office of Foreign Assets Control (OFAC) released guidance, in the form of frequently asked questions ("FAQs"), relating to Section 1245 of the National Defense Authorization Act of 2012 (the "NDAA"). As detailed in our previous advisory, Section 1245 of the NDAA enacts additional sanctions intended to isolate Iran further from the global economy. The Act:

Requires the President to prohibit the opening of, and prohibit or impose "strict conditions" on the maintenance of, U.S. correspondent or payable-through accounts of "foreign financial institutions" where such institutions are determined "knowingly" to have conducted or facilitated any "significant financial transaction" with the Central Bank of Iran ("CBI") or Iranian financial institutions that have been listed as Specially Designated Nationals by the Secretary of the Treasury;
Designates the entire Iranian financial sector as a "jurisdiction of primary money laundering concern," thereby triggering enhanced due diligence requirements on U.S. financial institutions under the USA PATRIOT Act;
Requires the President to block the property of any Iranian financial institution that is within the United States or within the possession of U.S. persons, and to prohibit all transactions by U.S. persons with any such property. As our previous advisory describes, President Obama issued Executive Order 13599 on February 5, 2012, which implements this provision, effective February 6, 2012.

While OFAC has not yet issued implementing regulations relating to the NDAA's provisions, the FAQs suggest that such regulations will be forthcoming. For example, OFAC's guidance states how the agency "anticipates" defining terms or interpreting provisions. Although the FAQs may not carry the force and effect of law, at present they represent OFAC's only public guidance interpreting the NDAA.

Key Definitions in New FAQ Guidance

OFAC's FAQs provide that the definitions of the NDAA's key terms will be based largely on existing statutory and/or regulatory definitions and interpretations.

"Significant financial transaction"

OFAC anticipates closely modeling the NDAA's definition of "significant financial transactions" based on the Iranian Financial Sanctions Regulations ("IFSR"), 31 C.F.R. Part 561, that were issued pursuant to the Iran Sanctions Act, as amended by the Comprehensive Iran Sanctions, Accountability and Divestment Act. Those regulations identify seven factors for purposes of determining a significant financial transaction: (1) the size, number, and frequency of transactions; (2) the nature of the transaction(s); (3) the level of awareness of management and whether the transaction(s) are part of a pattern of conduct; (4) the nexus between the transaction(s) and a blocked person; (5) the impact of the transaction(s) on statutory objectives; (6) whether the transaction(s) involve deceptive practices; and (7) such other factors as deemed relevant on a case-by-case basis.

OFAC defines "financial transaction" broadly to include "any transfer of value involving a financial institution." The term "transaction" includes, but is not limited to, the following:

the holding of nostro, vostro, or loro accounts for or with the Central Bank of Iran or designated banks, such as Bank Melli Iran and/or Bank Saderat Iran, including any of their branches or subsidiaries worldwide (collectively the "Listed Parties");
the provision of trade finance and/or letter of credit services for or with Listed Parties;
the provision of guarantees or similar instruments for or with Listed Parties;
the provision of investment products or instruments for Listed Parties and/or the participation with Listed Parties in investments;
the receipt or origination of wire transfers on behalf of or involving Listed Parties;
the acceptance of commercial paper (both retail and wholesale) drawn on Listed Parties, and the clearance of such paper (including, but not limited to, checks and similar drafts);
the receipt or origination of ACH or ATM transactions with Listed Parties; and/or
any other transactions for or on behalf of, directly or indirectly, Listed Parties and/or with Listed Parties serving as correspondents, respondents, or beneficiaries, including transactions where the Listed Parties do not appear on the face of the transaction but where the transaction is undertaken with knowledge of the involvement of a Listed Party based on a relationship that exists through a third party such as a money exchange or trading house.

The definition above covers essentially all types of financial transaction activity that would be relevant in a cross-border setting.

OFAC also lists examples of transactions that could fall under the definition of "significant financial transaction":

the provision of oil as payment for an outstanding debt, if the transfer involves a financial institution;
transactions in which the CBI is involved in providing settlement services, or is otherwise acting solely as an intermediary between a non-designated Iranian bank and a foreign financial institution;
barter trades with the CBI, if a transfer involves a financial institution; and
the passive holding of CBI reserves, in certain cases. The holding of CBI reserves would not be a "significant financial transaction" where the accounts are frozen or restricted, under which the CBI would be allowed to maintain accounts that it had already opened as of December 31, 2011, but would otherwise be unable to direct the disposition of those funds, with ordinary commercial interest payments and routine roll-overs of time deposits under pre-existing instructions being the only new transactions.

The inclusion of oil-as-payment and barter trades as "financial transactions" demonstrates the potential breadth of the sanctions, and also underscores the uncertainty that the sanctions present to foreign financial institutions.

Further, OFAC emphasizes that there is no general exception for payments arising out of pre-existing contracts. This includes transactions in which foreign financial institutions receive funds from the CBI to repay pre-existing loans.

"Knowingly"

The NDAA sanctions on foreign financial institutions apply if the institution is found "knowingly" to have engaged in the identified conduct. OFAC intends to model the definition of "knowingly" on the IFSR, which define the term to mean that a person has actual knowledge, or should have known, about the conduct, circumstance, or result at issue.

The "should have known" standard creates difficulties for companies in establishing appropriate due diligence measures, even though any business with Iran's financial sector should be viewed as high risk based on its designation as a primary money laundering concern. Further, under this standard, one cannot consciously disregard or ignore red flags where a question arises, for example, with respect to whether a transaction with a non-Iranian intermediary institution might involve an Iranian financial institution.

"Owned or controlled by the government of a foreign country"

OFAC provides that a financial institution "owned or controlled by the government of a foreign country" is one in which a foreign government owns a 50 percent or greater interest or which is otherwise controlled by a foreign government. This definition is anticipated to be modeled after the Iranian Transactions Regulations (the "ITR") definition of "an entity owned or controlled by the Government of Iran."

"Food, medicine, and medical devices"

The NDAA excludes from sanctions those transactions involving the sale of food, medicine, or medical devices to Iran, even if involving Iranian financial institutions. The definition of "food" is based on the definition set forth in the October 12, 2011 general license (76 Fed. Reg. 63191) authorizing the export of food to Iran and Sudan: "items that are intended to be consumed by and provide nutrition to humans or animals in Iran – including vitamins and minerals, food additives and supplements, and bottled drinking water – and seeds that germinate into items that are intended to be consumed by and provide nutrition to humans or animals in Iran." Food does not include alcoholic beverages, cigarettes, gum, or fertilizer.

The definitions of "medicine" and "medical device" are based on those set forth in the ITR and the Trade Sanctions Reform and Export Act ("TSRA"), which in turn assign the terms the same meaning as "drug" and "device," respectively, under the Federal Food, Drug, and Cosmetic Act. The ITR definitions add that "medicine" and "medical device" do not include any item listed on the Commerce Control List in the Export Administration Regulations.

"Foreign financial institution"

The NDAA's restrictions on significant financial transactions with the CBI or designated Iranian financial institutions apply to "foreign financial institutions." OFAC's FAQ guidance provides that this term will be based on the IFSR definition set forth at 31 C.F.R. § 561.308:

"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"

"Iranian financial institution"

The NDAA blocks (i.e., freezes) the property and interests in property of "Iranian financial institutions" held by U.S. persons or located in the United States, and places restrictions on certain business with such institutions. OFAC expects that its definition of this term will be based on Executive Order 13599, which covers "a financial institution organized under the laws of Iran or any jurisdiction within Iran (including foreign branches), any financial institution in Iran, any financial institution, wherever located, owned or controlled by the Government of Iran, and any financial institution, wherever located, owned or controlled by any of the foregoing."

OFAC's definition of "foreign financial institution" is virtually identical to "Iranian financial institutions." There is one notable difference, however, as insurance companies are included in the definition of "Iranian financial institutions", but not "foreign financial institutions."

"Significantly reduced"

The NDAA allows the President to forego imposing sanctions on a foreign financial institution if the country with primary jurisdiction over that institution has "significantly reduced its volume of crude oil purchases from Iran" over a specified period of time. In its FAQs, OFAC describes how the Secretary of State will determine whether a country has "significantly reduced" its importation of Iranian crude oil. The determination will involve an assessment of the quantity and percentage of the reduction over the relevant period, termination of contracts for future delivery of Iranian crude oil, and other actions that demonstrate a commitment to substantially decrease such purchases.

Notably, Senators Mark Kirk and Robert Menendez (who sponsored the amendment ultimately enacted as Section 1245 of the NDAA) set forth their views in a January 12, 2012 letter to Treasury Secretary Timothy Geithner as to how "significantly reduced" should be interpreted. Senators Kirk and Menendez advocated focusing on a reduction of "the bottom line amount of money" a country sends to Iran by purchasing crude oil, rather than a reduction of the volume of oil purchased. In doing so, they endorsed a recommendation of the Foundation for Defense of Democracies that the Treasury Department define "significantly reduced" as a minimum of 18 percent reduction in the total price paid, achieved through price discounts and/or import reductions, on an annualized basis. It is unclear whether the Administration will accept this recommendation.

"Petroleum products"

The NDAA provides that state-owned or -controlled foreign financial institutions, including central banks, are subject to sanctions only if they engage in transactions involving the sale or purchase of petroleum or "petroleum products" to or from Iran. OFAC interprets "petroleum products" in accordance with the definition of the U.S. Energy Information Administration (EIA), which defines "petroleum products" to include: unfinished oils, liquefied petroleum gases, pentanes plus, aviation gasoline, motor gasoline, naphtha-type jet fuel, kerosene-type jet fuel, kerosene, distillate fuel oil, residual fuel oil, petrochemical feedstocks, special naphthas, lubricants, waxes, petroleum coke, asphalt, road oil, still gas, and miscellaneous products obtained from the processing of crude oil (including lease condensate), natural gas, and other hydrocarbon compounds. While the definition is broad, it does not include natural gas, liquefied natural gas, biofuels, methanol, and other non-petroleum fuels.

Interaction with CISADA

OFAC makes clear that Section 1245 does not repeal or amend Section 104(c) of CISADA. This means that, regardless of the application of the NDAA, foreign financial institutions remain separately subject to sanctions where they facilitate the efforts of the Government of Iran to acquire or develop weapons of mass destruction, support terrorism or terrorist groups, facilitate the activities of SDNs and other sanctioned persons, facilitate significant transactions for the Islamic Revolutionary Guard Corps, or engage in other conduct proscribed under Section 104(c) of CISADA, e.g., money laundering related to any of foregoing.

OFAC further explains that CISADA sanctions apply only to foreign financial institutions engaged in the proscribed activities above. Executive Order 13599, which blocks the property of all Iranian financial institutions held by U.S. persons or in the United States under the NDAA, applies independently of CISADA.

Conclusion

Not surprisingly, OFAC has defined several of the NDAA's key terms in accordance with definitions set forth under other sanctions regimes. It also has provided several examples of what constitutes a "significant financial transaction," which in turn reveals its intent to take an expansive view of that term.Curiously, OFAC did not define "strict conditions," a term undefined in the NDAA, in its FAQs. We expect OFAC to interpret this term similarly to the definition set forth in the IFSR at 31 C.F.R. 561.201(b).

As OFAC explained, financial institutions should be mindful that while there are several exceptions and limiting factors to the NDAA sanctions, including a presidential signing statement, CISADA sanctions remain in full force.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.