OFAC Compliance: OFAC Compliance: How to Minimize the How to Minimize the

Threat of Threat of Costly ViolationsCostly Violations

April 17, 2008

This presentation is solely for informational purposes. It is not intended to constitute

legal advice or create an attorney-client relationship.

Context Tools

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“OFAC”“Office of Foreign Assets Control,” an enforcement

division of the United States Department of the Treasury

OFAC’s RoleAdministers and enforces economic and trade sanctions

against foreign governments and government officials and persons and entities identified on the SDN List as terrorists, drug traffickers, etc.

SDN List“Specially Designated Nationals and Blocked Persons

List”; identifies some 4,000 foreign nationals with whom transactions are prohibited; roughly 50 in U.S.

OFAC does not enforce USA Patriot Act amendments to 1970 Bank Secrecy Act requiring life insurers and certain others with “stored value” (investment, cash, etc.) products to have anti-money laundering program

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Two primary statutory bases for OFAC regs: The Trading with the Enemy Act of 1917 (“TWEA”) International Emergency Economic Powers

Act of 1977 (“IEEPA”)

U.S. Presidents, Kennedy (Cuba) through Clinton ([country]) declared “national emergency” in reaction from which regulations arise

Courts grant OFAC broad deference Allegations of OFAC arbitrariness

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OFAC does not enforce USA Patriot Act amendments to 1970 Bank Secrecy Act requiring life insurers and certain others with “stored value” (investment, cash, etc.) products to have anti-money laundering program

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• Apply corporate to all natural and persons subject to jurisdiction U.S.

• Prevent terrorists and drug traffickers from profiting through transactions with “U.S. Persons” subject to U.S. jurisdiction

• Objective standard: must not deal with embargoed countries, their residents or citizens or SDNs

• Require reinsurers to blocks assets of embargoed natural persons and entities

• Report to OFAC and, in general, inform person whose assets are affected

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• Applies to certain categories of “financial institutions,” including whole life insurers and others with “stored value” products, but not including reinsurers, P&C insurers

• Prevents terrorists and drug traffickers from profiting through money laundering activities with U.S. “financial institutions

• Subjective standard: totality of the circumstances and indicia of money laundering

• Requires companies to seize assets used as part of suspected money laundering

• Report suspicious activity to Treasury and do not inform suspect

Unintentional Violations: Potentially forfeit the value of the contract or payment plus

pay a fine Recent increase to $250,000 per IEEPA violation,

retroactively applied Mitigating Factors include:

Compliance Plan (25% - 50% reduction) First offense (25% - 50% reduction) Self-reported violations (50% or greater reduction)

Intentional Violations: fine double the amount of transaction, plus criminal fines and imprisonment

Reputation and Reporting Risks

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Broad EmbargosCuba Sudan Iran Myanmar (Burma)

Limited EmbargosRough Diamonds North KoreaIvory Coast (Côte d’Ivoire) Syria Iraq Palestinian AuthorityLiberia Zimbabwe

SDN List“Specially Designated Nationals and Blocked Persons” List of

roughly 4,000 foreign nationals – terrorists, drug traffickers and others (less than 100 known U.S. residents)

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Compliance Program Company Foreign Affiliates Employees

Education Systems

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OFAC does not require a compliance program Compliance is akin to strict liability A compliance program is favorably

considered as a mitigating factor

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Designate Compliance Officer(s) Conduct risk assessment Establish systems and documentation Train personnel Audit the program

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Legal, investigative or other relevant experience

Support from senior management Access to senior management and counsel Authority and resources to implement

program Consider collaboration with AML, privacy,

and international compliance functions

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Strict compliance, but with statutory objectives in mind

Statutory Objectives include: Do not facilitate terrorist activity or drug trafficking Do not facilitate trade with embargoed countries,

entities or individuals Pragmatic approach: allocate compliance

resources to greatest exposures first and lesser exposures later

This approach will not necessarily avoid violation, but mitigates risk of harm

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Consider the nature of the transaction Could the transaction facilitate terrorist activity or

drug trafficking? Sending funds to unfamiliar foreign client vs.

claims payment to known U.S. client Consider the sums involved:

$200 contract vs. $2,000,000 contract Not limited to insurance products

Should evaluate Company’s investments and other transactions

Potential focus: fund flow portals

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Those disqualified by designation: Approximately 100 records on the SDN List have

U.S. addresses: 60% full addresses Some with only name, city and state with name and country

Those disqualified by status: Government officials of blocked countries

primarily reside in foreign countries Nationals of blocked countries illegally in

U.S. – identification issues?

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Company’s foreign offices and operations, including employees, outsourcing contractors, vendors

Clients’ foreign offices and operations Individual clients residing in foreign

countries Consider country of residence and nationality

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Compliance Alternatives include: Manual with paper lists – audit trails? Manual with automated lookup tool Automated Filters Outsourcing

Compliance Requirements Comprehensive and up-to-date OFAC database Reliable, robust and rapid access to data

Catch actual matches Minimize false matches

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Suggestions for final documentation set: Summary of OFAC regulations and compliance

goals Screening, due diligence, reporting and training

procedures Responsibilities of involved personnel Document retention protocol Disciplinary procedures for employee and

business partner non-compliance

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Internal audit is generally sufficient Consider “Independent” internal auditor

Separate audit from compliance function Auditor reports directly to senior management

Consider evaluating whether appropriate program elements are in place, such as: Compliance Officer Risk assessment Systems and Documentation Training

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New clients and business partners screened? Existing databases periodically scrubbed? Appropriate due diligence for “hits”? Assets blocked when matches are found? Timely OFAC reporting: 10 days from

blocking and September 30 annual report Employees informed of program? Compliance “tested” with actual hits?

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Foreign Parent/Subsidiary Issues Avoiding Liability for Evading and Avoiding Conflicting Foreign Laws Application to U.S. Citizens Working Abroad

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Foreign Parent/Subsidiary Issues Avoiding Liability for Evading and Avoiding Conflicting Foreign Laws Application to U.S. Citizens Working Abroad

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U.S. operations are subject to OFAC regulations. U.S. offices cannot originate, underwrite,

participate in or supervise any transactions with US embargoed countries or persons.

U.S. company’s foreign branches also subject to OFAC regulations

Non-U.S. parent of company: Overseas operations, to the extent those operations do not involve U.S. offices, are not subject to OFAC regulations.

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Is the U.S. Company’s involvement with the foreign company sufficient to constitute “control” under the U.S. embargo laws?

OFAC is likely to assert that a U.S. Company is “dealing” with embargoed countries or persons, if the U.S. Company’s personnel directly supervise the foreign company’s transactions with U.S. embargoed countries or persons or provide administrative support specifically for US embargoed transactions.

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CACRs extend to “any person subject to the jurisdiction of the United States.”

“Persons subject to the jurisdiction of the United States” includes: (1) any individual or entity within the U.S.;(2) any entity organized under the laws of the U.S.; and (3) any entity, wherever organized or doing business,

that is owned or controlled by individuals or entities located in or organized under the laws of the U.S.

CACRs apply extraterritorially to subsidiaries of U.S. entities

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Most other OFAC regulations extend to “U.S. Persons”

“U.S. Persons” include: (1) any citizen or individual or entity within the U.S.;

and

(2) any entity organized under the laws of the U.S., including foreign branches

CACRs apply extraterritorially only to foreign branches of U.S. entities

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General management control over a sister company unlikely sufficient to make sister company “subject to the jurisdiction of the United States” under CACRs.

But foreign sister company might be considered a “person subject to the jurisdiction of the United States” if it were “controlled” by U.S. sister

Or, if U.S. sister becomes sufficiently involved in foreign sister’s transactions with embargoed countries, then OFAC may view U.S. sister’s involvement as “dealings in” transactions with the embargoed countries

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OFAC has broad latitude in its interpretation of its embargo regulations and the prohibition on “evading or avoiding” the prohibitions set forth in the regulations.

Foreign Parent must originate and implement any organizational changes necessary to ensure that U.S. Company has no actual or structural control over transactions involving US embargoed countries.

OFAC could potentially assert that U.S. Company was seeking to “evade or avoid” the regulations by reorganizing its management responsibility to carve out any transactions with US embargoed countries. Sudanese regulations expressly note that no U.S. Person can

change its policies or procedures, or those of an affiliate or subsidiary, in order to enable a foreign entity owned or controlled by U.S. Persons to enter into otherwise prohibited transaction.

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Canadian law prohibits Canadian domiciled companies from acceding to demands to comply with the United States’ embargo of Cuba.

EU, UK, Mexico and Argentina have similar countermeasures designed to prohibit EU, UK and Mexico domiciled companies from acceding to such demands

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The Wal-Mart Conundrum? Or the Solution? U.S. Parent discovers Canadian Subsidiary selling

pajamas made in Cuba Instructs Sub to remove from shelves Managers of Sub refuse based on Canadian

Foreign Extraterritorial Measures Act and Canadian AG instructs Sub not to comply

Did U.S. Parent have “control” of its Sub with respect to this transaction?

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OFAC Sanctions Programs apply to U.S. Citizens working abroad as employees, managers, officers or directors of a Company

U.S. Citizens, wherever located, can have no direct involvement in prohibited transactions

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U.S. citizens will not be liable for the Company’s transactions with countries or persons embargoed by the U.S. if: The U.S. Citizen has no direct involvement in

transactions with the embargoed country (i.e., does not vote on, approve, or otherwise become directly involved) and

The Company’s transactions with embargoed countries are not a significant part of the Company’s business.

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If the Company's transactions with embargoed countries are a significant part of the company’s business, then a U.S. Citizen’s involvement could be deemed to be direct involvement in the transactions.

May become necessary to seek a specific license from OFAC for the management or board position.

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Due Diligence OFAC Compliance Program SDN Screening systems Prior OFAC investigation/sanction history Language in contracts/agreements

Warranty or Indemnity Protections Consider warranty affirming compliance with

OFAC regulations

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Consider contract wording: Minimally, include wording that all parties to the

contract are in compliance with applicable law. Ideally, include more specific wording addressing

compliance with TWEA, IEEPA and OFAC Regulations

Potential benefits of contract wording Mitigation factor in event of violation Dialogue with business persons regarding OFAC

Compliance Due diligence

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License authorizes party to engage in otherwise prohibited transaction or activity

General License Authorized under OFAC regulations, e.g.,

transactions with Cuban National legally residing in U.S.

Specific License Issued by OFAC for specific activity, e.g.,

medical shipment to Iran

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Apply to OFAC, identifying circumstances, interested parties and relevant documents

After exhaustion of administrative remedies, denial of license application potentially appealable to U.S. District Court, but… OFAC has broad discretion Courts are unlikely to disturb OFAC’s decision,

except in egregious circumstances

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Source: Statement of OFAC Director, R. Richard Newcomb, before Senate Appropriations Committee Subcommittee on Treasury and General Government, May 10, 2001, U.S. Treasury Release No. PO-370

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Sanctions now publicized on the Internet: www.ustreas.gov/ofac

Sanctions or proposed sanctions reported by OFAC: Major international insurer, March 2001

Cuban sanctions program Amount: Apx. $2.4 million

Major Bank, May 2004 Cuban, Iranian, Libyan sanctions programs Amount: $100 million

Major bank, January 2006 Iranian and former Libyan sanctions programs Funds transfers involving Iranian bank Amount: $40 million

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Pre-penalty Notice and Response: similar in some respects to complaint and answer in litigation

Options• Pre-penalty settlement

Alleged violator pays penalty in agreed amount OFAC withdraws claim and makes no final determination

of violation• Potential administrative hearing on alleged

violation Discovery Presentation of evidence

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Potential claims for failure to timely perform under valid contract due to defective compliance protocol e.g., slow or inadequate due diligence in response to SDN List “hit”

Potential discrimination claim if systemic defects in compliance protocol lead to defacto redlining based on surnames (But note TWEA and IEEPA immunity provisions for “good faith” efforts to comply)

Potential for claims by those injured in terrorist attack facilitated by non-compliance

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OFAC’s Internet Site http://www.ustreas.gov/ofac

OFAC’s Compliance Hotline (202) 622-2490

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Scott Ostericher

Hinkhouse Williams Walsh LLP200 East Randolph Street

24th FloorChicago, Illinois 60601

312.729.1569 (d)312-505-3147 (m)

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sostericher@hww-law.com