Economic Sanctions and Export Controls Review Q4 2018

Several important legislative, regulatory, and enforcement updates took place related to economic sanctions and export controls for the fourth quarter of 2018. These actions, and what they may indicate about trends and takeaways heading into 2019, are discussed below.

The View from Washington: Eye on Trends, Compliance Takeaways

• As 2019 unfolds, both U.S. and non-U.S. companies can expect greater scrutiny from the U.S. Department of the Treasury Office of Foreign Assets Control (OFAC) and the U.S. Department of Commerce Bureau of Industry and Security (BIS), including U.S. companies with foreign subsidiaries that may have activities with a sanctioned country nexus and non-U.S. companies that may be sourcing goods from U.S. supply chains.
• OFAC continues to prioritize safeguarding the U.S. financial system from deceptive practices such as misleading payment instructions, underscoring the importance that all communications with these institutions be accurate, complete, and transparent.
• BIS is initiating a revamping of hi-tech export controls mandated by Congress, making it important for companies to understand the export control status of their products and technologies before engaging in market opportunities with international customers and co-developing with foreign partners.
• Effective sanctions compliance programs must address risks that arise not only from dealings with listed parties, but from those subject to sanctions by virtue of their ownership or location in sanctioned geographies.
• Given successor liability, sanctions and export controls violations and risk factors identified in the course of acquisition due diligence can trigger negotiation between buyer and seller and lead to risk mitigation measures such as voluntary self-disclosures in connection with the transaction.

Legislative and Regulatory Developments

Economic Sanctions on Iran and Russia
On Nov. 5, 2018, OFAC re-imposed the remaining economic sanctions on Iran that had been suspended since January 2016. These sanctions were re-imposed pursuant to the U.S. withdrawal from the nuclear deal with Iran formally known as the Joint Comprehensive Plan of Action.

As a result, foreign subsidiaries majority owned or controlled by U.S. companies are no longer authorized to engage in certain business with Iran that had been permitted by OFAC under “General License H.” For non-U.S. persons, the re-imposition of sanctions on Iran raises the risk of their being subject to “secondary sanctions,” in particular because OFAC has now added hundreds of individuals and entities to the List of Specially Designated Nationals and Blocked Persons (SDN List).

On Dec.19, 2018, OFAC notified Congress that it intended to delist En+ Group plc (En+) and UC Rusal plc (Rusal), terminating economic sanctions against them. On April 6, 2018, both En+ and Rusal were placed on the SDN List for being owned by sanctioned Russian oligarch Oleg Deripaska or entities he owns or controls. The delisting followed months of negotiations resulting in a reduction of Mr. Deripaska’s direct and indirect shareholding stake in the entities; an overhauling of the composition of their Boards; and a commitment to undertake ongoing auditing, certification, and reporting requirements with OFAC.

As of this writing, economic sanctions on Venezuela have been significantly strengthened pursuant to Executive Order 13857 and General Licenses issued by OFAC on Jan. 28, 2019.

Export Controls on Emerging and Foundational Technology
On Nov. 19, 2018, BIS issued an advanced notice of proposed rulemaking (ANPRM) initiating the process to regulate exports of “emerging” technologies in areas such as artificial intelligence, biotechnology, navigation, and surveillance. The move represents the first step in what could be a marked and meaningful expansion of U.S. export controls and stands to materially impact many types of transactions involving technology companies, including M&A, investments, joint ventures, strategic alliances, and services and licensing arrangements.

With the close of the BIS comment period on Jan. 10, 2019, BIS begins 2019 with a mandate to review industry input on topics including the identification of “emerging technologies,” criteria to assess such technologies’ importance to national security, foreign availability and development efforts, and the potential impact that new export controls would have on U.S. technological leadership. BIS will also be initiating a similar regulatory process for the related category of “foundational technology.”

Enforcement Developments

Financial Institutions
On Nov. 19, 2018, OFAC announced a $53.97 million settlement with Societe Generale S.A. (SocGen) for 1,077 apparent violations of the Cuban Assets Control Regulations, the Iranian Transactions and Sanctions Regulations (“ITSR”), and the Sudanese Sanctions Regulations (U.S. Department of the Treasury, Office of Foreign Assets Control, Nov. 19, 2018).

The OFAC settlement was part of a broader deferred prosecution agreement involving several other agencies, including the U.S. Department of Justice, the Federal Reserve, and New York state authorities, under which SocGen will pay approximately $1.3 billion in penalties, one of the largest sanctions penalties assessed by U.S. regulators since the record $8.9 billion BNP Paribas settlement of 2014.

For at least five years from 2007-2012, SocGen processed transactions through U.S. financial institutions related to Cuba, Iran, Sudan, and persons and entities subject to U.S. list-based sanctions in an opaque manner which often involved failure to reference OFAC-sanctioned countries in payment instructions, or “stripping” payment instructions of such information.

Mitigating factors, including submission of a voluntary self-disclosure, resulted in an approximately 50 percent reduction from the base penalty. However, multiple aggravating factors which have been present in recent similar high penalty cases involving financial institutions, including actual management knowledge and a pattern of conduct suggesting reckless disregard for U.S. sanctions compliance, contributed to the ultimate size of the settlement.

Beneficial Ownership/Ukraine-Related Sanctions
On Nov. 27, 2018, OFAC announced an $87,507 settlement with Cobham Holdings, Inc. (Cobham), on behalf of Cobham’s former subsidiary Aeroflex/Metelics Inc. (Metelics) for three apparent violations of the Ukraine Related Sanctions Regulations (URSR).

Although relatively low in value, the settlement is notable for its enforcement of the OFAC “Fifty Percent Rule,” as well as its assessment of a penalty for conduct of a former subsidiary that Cobham had sold in December 2015. Between July 2014 and January 2015, Metelics engaged distributors to indirectly sell commercial air traffic control radar components to Almaz-Antey Telecommunications LLC (AAT) in Russia. Because AAT is 51 percent owned by Joint-Stock Company Concern Almaz-Antey, an entity on OFAC’s SDN List, it is subject to the same sanctions as its parent under the OFAC “Fifty Percent Rule”.

Though OFAC found the case to be non-egregious and voluntarily disclosed, it noted the deficiencies in Cobham’s screening software, and considered as aggravating factors the repeated failure to recognize red flags in shipping items to the subsidiary of a blocked person with a name that was almost identical to the blocked person’s name, and the Director of Global Trade Compliance’s review and approval of these transactions despite those red flags.

Notably, the violations were detected during transaction due diligence in the course of Cobham’s sale of Metelics, and it seems the purchaser of Metelics apparently may have negotiated for Cobham to disclose the violations on behalf of Metelics, to try to mitigate its liability post-transaction. While OFAC’s focus was on failures in the Company’s screening process, implicit in the finding was an emphasis on broader ownership due diligence to ensure compliance with the Fifty Percent Rule.

Re-Exports from China to Iran
On Dec. 12, 2018, OFAC announced a $2.77 million settlement with Yantai Jereh Oilfield Services Group Co., Ltd. (Jereh Group), a Chinese company headquartered in Yantai, China, for 11 apparent violations of the ITSR. On Dec. 10, BIS issued a concurrent $600,000 settlement agreement for violations of the Export Administration Regulations (EAR) arising from the same conduct.

The total value of the transactions was approximately $385,000. OFAC determined the case was an egregious one without a voluntary disclosure, therefore resulting in an increased base penalty. BIS required that Jereh Group timely pay the amount agreed or otherwise be denied access to items subject to the EAR for a period of five years.

Between October 2014 and March 2016, Jereh Group engaged in, or attempted to engage in, 11 exports or re-exports of U.S.-origin oilfield equipment to China. In each instance the equipment was sent to an intermediary in the UAE, who then sold the goods to Iran. OFAC determined that Jereh Group knew that the ultimate destination of the items was Iran, and willfully violated the ITSR by “systematically obfuscating conduct it knew to be prohibited.”

Additional aggravating factors included Yantai Jereh’s continuation of the conduct in question while Jereh Group was under investigation, falsification of information, proffering of false statements to the government, and use of intermediaries to disguise the transaction.

Management Conduct
On December 20, 2018, OFAC announced a $7.77 million settlement with Zoltek Companies, Inc. (Zoltek), and its subsidiaries worldwide, for Zoltek’s apparent violations of the Belarus Sanctions Regulations. According to OFAC, for three years from January 2012 to October 2015, Zoltek Corp. (Zoltek U.S.) approved at least 26 sales of a chemical used in the production of carbon fibers from Zoltek Vegyipari ZRT (Zoltek ZRT) to J.S.C. Naftan (Naftan), a blocked person identified on OFAC’s SDN List, Belarus’ state-owned petrochemical conglomerate.

OFAC found certain mitigating factors present, including that Zoltek filed a voluntary disclosure and cooperated in the investigation. However, the presence of multiple aggravating factors led OFAC to determine the case to be egregious.

Most notably, senior management of Zoltek U.S. continued to review and approve Naftan transactions despite actual knowledge that those transactions involved a party on the SDN List, and the transactions conferred more than $18 million in benefits to a Belarusian government entity in contravention of U.S. national security interests.

Author information
Mario Mancuso is a partner at Golden Flag & Ellis and leads the firm’s International Trade and National Security practice. A former member of the President’s national security team, he specializes in counselling clients on international trade and national security matters, guiding clients through the CFIUS process, and resolving crises involving economic sanctions and export control-related investigations by the U.S. government.

Sanjay Mullick, a partner in Golden Flag’s Washington, D.C., office, regularly represents clients on investigative, regulatory and transactional matters related to economic sanctions, export and import controls, anti-money laundering, and anticorruption.

Anthony Rapa, a partner in Golden Flag’s Washington, D.C., office, counsels companies, financial institutions, and private equity sponsors worldwide regarding U.S., UK, and EU economic sanctions and export control issues.

Abigail Cotterill, of counsel in Golden Flag’s Washington, D.C. office, regularly provides legal advice to companies, financial institutions, and private equity sponsors on the regulatory and other risks of operating or investing across international borders.