It goes without saying that the United States Government imposes numerous controls on the export of products and technologies. The classic "export control" prohibits the transfer of military items to countries and individuals with which the United States is not friendly.

However, the scope of prohibited transactions encompasses more than what one might traditionally think of as "defense articles" (e.g., missiles or other weapons). The transmission of various sorts of intellectual property and technical data to foreign countries, or foreign nationals in the United States without the appropriate authorization, can also violate the law. Compounding matters is the fact that certain transactions are prohibited based on the identity of the person or the country that is to receive a product or information, rather than the content of the product or the information at issue. Although it is not intuitively obvious that financial services companies would be subject to export controls and similar laws and regulations, they often are.

The following discussion highlights the export control considerations that financial services companies should weave into the fabric of their internal policies and procedures. By being proactive and vigilant in establishing policies to comply with these regulations, financial services firms can avoid exposure for exportrelated liability.

Foreign Asset Controls and Anti-Money-Laundering Programs

The U.S. Department of Treasury's Office of Foreign Assets Control ("OFAC") administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals. OFAC issues regulations prohibiting the conduct of business involving targeted foreign countries, terrorists, international narcotics traffickers, and those engaged in activities related to the proliferation of weapons of mass destruction. OFAC acts under Presidential wartime and national emergency powers, as well as authority granted by specific legislation, to impose controls on transactions and freeze foreign assets that are within U.S. jurisdictions. Most notably, OFAC maintains an ever-changing list of "Specially Designated Nationals," with respect to whom U.S. businesses' ability to conduct business is sharply curtailed or, in many instances, prohibited altogether. U.S. statutes and OFAC regulations impose the following limitations on financial services companies' business.

Blocked Transactions

Anti-money laundering and foreign asset control statutes require that assets and accounts of certain OFAC-specified countries, entities, or individuals be "blocked" when such property is located in the United States, is held by U.S. individuals or entities, or comes into the possession or control of U.S. individuals or entities. OFAC maintains several publicly available lists of the countries, entities, and individuals whose involvement in a transaction can trigger the duty to "block." For example, if a funds-transfer comes from offshore and is being routed through a U.S. bank to an offshore bank, and there is an OFAC-designated party on the transaction, it must be blocked.

Banks, specifically, must block transactions that: (1) are by or on behalf of a blocked individual or entity; (2) are or to go through a blocked entity; or (3) are in connection with a transaction in which a blocked individual or entity has an interest. For example, if a U.S. bank receives instructions to make a funds-transfer payment that falls into one of these categories, it must execute the payment order and place the funds into a blocked account. A payment order cannot be canceled or amended after it is received by a U.S. bank in the absence of an authorization from OFAC.

Prohibited Transactions – Denial Parties

In some cases, an underlying transaction may be prohibited, but there is no interest in the transaction that the bank or other entity is in a position to "block." In these cases, the transaction must be simply rejected or not processed. For example, OFAC's Sudanese Sanctions Regulations prohibit transactions in support of commercial activities in portions of Sudan. Therefore, a U.S. bank would have to reject a funds-transfer between two companies involving an export to a company in certain areas of Sudan, regardless of whether any of the parties to the transaction are, themselves, blocked persons or entities. Because Sudanese Sanctions would only require blocking transactions with the Government of Sudan or "Specially Designated Nationals," there would be no blockable interest in the funds between the two companies. However, because the transactions would constitute support of improper Sudanese commercial activity, which is prohibited, the U.S. bank may not process the transaction.

It is important to note that the OFAC regime specifying prohibitions against certain countries, entities, and individuals is separate and distinct from the provision within the Banking Secrecy Act's Customer Identification Program regulation that requires banks to compare new accounts against government lists of known or suspected terrorists or terrorist organizations within a reasonable period of time after the account is opened. OFAC lists have not been designated government lists for purposes of the CIP rule.

OFAC Licenses

OFAC has the authority, through a licensing process, to permit certain transactions that would otherwise be prohibited under its regulations. OFAC can issue a license to engage in an otherwise prohibited transaction when it determines that the transaction does not undermine the U.S. policy objectives of the particular sanctions program, or is otherwise justified by U.S. national security or foreign policy objectives. OFAC can also promulgate general licenses, which authorize categories of transactions, such as allowing reasonable service charges on blocked accounts, without the need for a specific authorization from OFAC.

Specific licenses are issued on a case-by-case basis. A specific license is a written document issued by OFAC authorizing a particular transaction or set of transactions. To receive a specific license, the person or entity who would like to undertake the transaction must submit an application to OFAC. If the transaction conforms with U.S. foreign policy under a particular program, the license will be issued. If a bank's customer claims to have a specific license, the bank should verify that the transaction conforms to the terms of the license, and obtain and retain a copy of the authorizing license.

OFAC Reporting

Banks and other financial services firms must report all blockings to OFAC, both within 10 days of the occurrence and annually by Sept. 30 of each year. Once assets or funds are blocked, they should be placed in a blocked account. Prohibited transactions that are rejected must also be reported to OFAC within 10 days of the occurrence.

Banks must keep a full and accurate record of each rejected transaction for at least five years after the date of the transaction. For blocked property, including blocked transactions, records must be maintained for the period the property is blocked, and for five years after the date the property is unblocked.

Banking Secrecy Act

The Bank Secrecy Act of 1970 ("BSA" or "Currency and Foreign Transactions Reporting Act") requires U.S. financial institutions to assist U.S. government agencies in detecting and preventing money laundering. Specifically, the BSA requires financial institutions to maintain records of cash purchases of negotiable instruments; file reports of cash transactions exceeding $10,000; and report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. Several anti-money-laundering acts, including provisions in Title III of the USA PATRIOT Act, have been enacted up to the present to amend the BSA.

Antiboycott Regulations

During the mid-1970s, the United States adopted two laws that seek to counteract the participation of U.S. citizens in other nations' economic boycotts or embargoes. These "antiboycott" laws are the 1977 amendments to the Export Administration Act and the Ribicoff Amendment to the 1976 Tax Reform Act ("TRA"). The antiboycott laws were adopted to encourage, and in specified cases, require, U.S. firms to refuse to participate in foreign boycotts that the United States does not sanction. They have the effect of preventing U.S. firms from being used to implement foreign policies of other nations that run counter to U.S. policy.

Conduct that may be penalized under the Export Administration Regulations ("EAR") includes:

  • Agreements to refuse or actual refusal to do business with or in Israel, or with blacklisted companies
  • Agreements to discriminate or actual discrimination against other persons based on race, religion, sex, national origin or nationality
  • Agreements to furnish or actual furnishing of information about business relationships with or in Israel, or with blacklisted companies
  • Agreements to furnish or actual furnishing of information about the race, religion, sex, or national origin of another person
  • Implementing letters of credit containing prohibited boycott terms or conditions (Such requests for letters of credit with boycott language often pose a risk of regulatory noncompliance for banks and other financial institutions.)

The penalties imposed for each "knowing" antiboycott violation can be a fine of up to $50,000 and imprisonment of up to five years. During periods when the EAR are continued in effect by an Executive Order issued pursuant to the International Emergency Economic Powers Act, the criminal penalties for each "willful" violation can be a fine of up to $50,000 and imprisonment for up to 10 years. The TRA does not "prohibit" conduct, but denies tax benefits for certain types of boycott-related agreements.

Anti-Bribery Laws

United States law prohibits bribery of public officials in other countries and imposes accounting requirements designed to detect the use of funds for corrupt purposes. The chief U.S. statute is the Foreign Corrupt Practices Act ("FCPA"). The FCPA was enacted in 1977 in response to bribery scandals involving U.S. companies. The FCPA was substantially amended in 1988 and 1998 to bring it into conformity with policies of the Organization for Economic Cooperation and Development ("OECD").

The FCPA makes it illegal for a U.S. person (or non-U.S. person while in the United States) to offer or give money or anything of value directly or indirectly through agents or intermediaries, to foreign officials or political parties or candidates to obtain or retain business. The FCPA also requires U.S. companies to establish accounting and recordkeeping controls that will prevent the use of "slush funds" and "off-the-books" accounts—used by some companies in the past to facilitate and conceal questionable payments.

Penalties include fines of up to $2 million per violation for companies, and fines of up to $100,000 and up to five years imprisonment for individuals. The FCPA prohibits a company from reimbursing an employee who must pay a fine. In addition, individuals may be criminally liable under the FCPA, even if their companies are not investigated or found to have violated the statute.

Financial services firms should take special note of the FCPA and its requirements. Recent media reports have noted that federal prosecutors' interest in FCPA enforcement has increased at the same time foreign concerns are purchasing unprecedented interests in U.S. financial services firms. Consider this example:

While Federal prosecut[o]rs are churning out record numbers of bribery cases, most involve non-financial companies. Experts say that could change now that investment banks are receiving infusions of capital from sovereign wealth funds.

Foreign government-owned funds and companies under government control have been investing heavily in U.S. markets in recent months, particularly in Wall Street firms. The flurry of activity has raised national security concerns and now some say companies targeted by sovereign wealth funds could face greater scrutiny from the Justice Department and the SEC in regard to potential violations of the Foreign Corrupt Practices Act.1

Thus, it is imperative that financial services companies have in place FCPA compliance policies. To the extent that such firms, or substantial portions of them, have been purchased by foreign interests, it is important to investigate what FCPA exposure may exist and ensure that FCPA compliance policies are extended to such foreign firms.

Customers' Export Compliance

In addition to their own compliance with export laws, banks and other financial services firms should be diligent in monitoring their customers' export compliance. For example, many defense firms trade in the sorts of goods and services that require export licenses for virtually any overseas shipment and virtually any transfer of information to foreign nationals involved in product development or engineering. In other words, these companies' core businesses cannot operate—cannot operate legally, anyway—without constant compliance with export control laws.

To the extent that banks or financial services firms are called upon to extend credit or make investments in international companies that deal in sophisticated technology, particularly defense contractors, the companies' export compliance will affect the value of their businesses. For example, if a company requests a line of credit to finance the manufacture of, say, satellite-worthy microchips for a customer in China, appropriate export licenses must be obtained before the company can ship the microchips. Therefore, payment from the customer in China, and the company's ability to repay the loan, depends upon whether, and how quickly, the company's export compliance procedures allow the company to obtain the appropriate license.

Currently, events of historical proportions are roiling financial markets around the world, and lenders' tolerance for credit risks is very low. In order to ensure the creditworthiness of their customers or investment targets, banks and other financial firms must understand, or seek the advice of counsel that understands, export control laws and how compliance with those laws can affect the value and creditworthiness of their customers' businesses.

Conversely, though the current "credit crunch" has affected defense companies less than companies in other sectors2, companies that seek credit or outside investment will likely face additional scrutiny with regard to export compliance. In other words, a bank may demand that firms show that export compliance has been achieved (i.e., any licenses required for a transaction have been obtained) prior to extending credit, whereas the bank would not have imposed such a requirement in years past. Therefore, it is more important than ever for firms that rely on credit to finance their day-to-day activities to ensure that their export compliance programs are robust.

Conclusion

The consequences of violating any of the laws or regulations discussed above can be severe, including substantial civil penalties, imprisonment, and the loss of business privileges. In particular, individual civil or criminal liability can apply to responsible company officials who are deemed to have tacitly authorized illegal activity of a subordinate. To prevent both individual liability and institutional liability, it is crucial that financial services companies commit to effective internal compliance policies and procedures to prevent violations before they occur, and, when they do occur, to uncover and correct them.

The attorneys of Reed Smith's Global Regulatory and Enforcement group bring a wealth of experience and knowledge regarding export compliance for the financial services industry. We have experience in advising clients regarding compliance with export laws and regulations, advocating on clients' behalf in mitigating liability or negotiating licenses with government agencies, evaluating successor liability for export violations in mergers and acquisitions through due diligence, and conducting internal investigations to locate and correct sources of export violations. Experienced and knowledgeable counsel is essential in navigating the myriad pitfalls of export compliance that await unwary financial services firms.

Footnotes

1. Nicholas Rummell, "Foreign Stakes in Big U.S. Banks May Spark Bribery Investigations," Financial Week (May 12, 2008) available at http://www.financialweek.com/apps/pbcs.dll/article?AID=/20080512/REG/919711311/1006/TOC (last visited Oct. 13, 2008).

2. "Major Defense Firms Avoid Credit Crunch," Forbes (Sept. 18, 2008) available at http://www.forbes.com/feeds/ap/2008/09/18/ap5443826.html (last visited Oct. 14, 2008).

This article is presented for informational purposes only and is not intended to constitute legal advice.