Trump Administration Implements Congressionally Mandated Russia Sanctions – Significant Presidential Discretion Remains

November 21, 2017

Over the past few weeks the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) and the U.S. State Department have issued their first round of guidance documents concerning how the Trump Administration will implement the “Countering America’s Adversaries Through Sanctions Act” (H.R. 3364) (“CAATSA” or “the Act”).[1]  This law, which we analyzed in our August alert, Congress Seeks to Force (and Tie) President’s Hand on Sanctions Through Passage of Significant New Law Codifying and Expanding U.S. Sanctions on Russia, North Korea, and Iran, is the most significant sanctions legislation in several years.

Despite President Trump’s opposition to CAATSA, the law passed with veto-proof majorities in both the House of Representatives and the Senate.  As a result, though the President noted that he still saw the bill as “seriously flawed,” he signed it into law on August 2, 2017.[2]  The Act requires OFAC and the State Department to publish guidance to notify the public how the Administration plans to enforce the new law.  This client alert provides an overview and analysis of the first tranche of required guidance.  The alert focuses on the broadest section of the law—Title II of the Act, titled the “Countering Russian Influence in Europe and Eurasia Act of 2017” (“CRIEEA”)—which significantly expands sanctions targeting the Russian Federation.

Though the law is complex, Title II operates principally by codifying and expanding upon existing sectoral and secondary sanctions against Russia, attempting to reanimate a number of regulations that date back to the Obama Administration but that had never been fully utilized.  First, the Act codifies and expands upon the “sectoral” sanctions programs created by President Obama in July 2014 to target Russia’s financial services, energy, metals and mining, engineering, and “defense and related materiel” sectors.[3]  Second, the Act sets forth a series of “secondary sanctions that can be imposed on persons not otherwise subject to U.S. jurisdiction who engage in certain transactions with Russia’s energy, defense and intelligence sectors.[4]

CAATSA is the latest and boldest example of the U.S. legislative branch’s increasing willingness to engage in the sanctions arena, an area which has traditionally been the responsibility of the Executive.  The Trump Administration’s admonishment to Congress cautioning against these new sanctions followed in the footsteps of prior administrations that had also warned Congress against legislatively-imposed sanctions due to a concern that they reduce a President’s flexibility in (and control over) foreign policy.  However, in nearly all other prior cases the Executive and Legislative branches eventually came to an agreement on sanctions legislation such that once the sanctions laws had passed, the Executive immediately set about implementing them.

The same is not true here.

Consequently, the passage of CAATSA left much uncertainty over how the sanctions provisions would be implemented, if at all.  As we noted in August prior to the issuance of any guidance by the Executive branch, even though parts of CAATSA are written as mandatory provisions, the legislation appeared to leave open the possibility for the Executive to either refrain from implementing significant portions of CAATSA or to implement sections of the law less robustly than the Congress may have wished.  Though some of the recent agency guidance indicates a strong enforcement posture, taken as a whole the guidance confirms this initial analysis: the President retains substantial discretion to not implement—or to weakly implement—large portions of the new law.  Early indications are that he will use this discretion frequently and broadly.

As an early marker of this conclusion, in a departure from historic practice and as discussed below, both the OFAC and the State Department guidance devote significant attention not just to how they will implement the law but also what they are not going to do and why.

I.  Sectoral Sanctions

CAATSA codifies and expands upon the sectoral sanctions programs created by President Obama in March 2014 to target Russia’s financial services, energy, metals and mining, engineering, and “defense and related materiel” sectors.[5]  These sectoral sanctions were implemented through a series of OFAC “Directives” restricting only certain types of activities with specified entities.  All other transactions with SSI entities remain permitted.  OFAC identifies the entities facing these restrictions on the SSI List.[6]  In accordance with OFAC’s “Fifty Percent Rule,” prohibitions described in the Directives extend to entities owned 50 percent or more or identified as controlled by a listed SSI entity.[7]

OFAC’s Russia Sanctions 101

Whenever there is a change or expansion of U.S. sanctions policy, we find it useful to revisit some of the basic tenets of U.S. sanctions. As a matter of first principles, U.S. sanctions have two principal means of targeting an activity: (1) designating the activity as per se sanctionable; and/or (2) sanctioning persons for engaging in those activities.

  • SDN vs. SSI Designations: There are several types of ‘designations’ for purposes of OFAC’s Russia sanctions: most importantly, Specially Designated Nationals (“SDNs”) and Sectoral Sanctions Identifications (“SSIs”). U.S. persons are generally prohibited from dealing with any person or entity on the “SDN List” and all assets under U.S. jurisdiction that are owned or controlled by the SDN are frozen. Under the SSI or sectoral designations, U.S. persons are prohibited from engaging in certain types of activities with SSI entities. A sectoral designation does not result in a complete prohibition on all interactions as with SDNs and SSI assets are not frozen. The precise restrictions on SSI entities are set forth in a series of “directives” that we describe below.
  • Primary vs. Secondary Sanctions: OFAC may also prohibit certain activities. Under its “primary” sanctions, U.S. persons who engage in prohibited activities (including dealing with an SDN or a sanctioned country) could face civil and criminal penalties, as could any person (U.S. or non-U.S.) who causes a violation to occur in U.S. territory, such as by causing a U.S. financial institution to process a prohibited transaction. Whereas U.S. persons often face civil and criminal penalties for engaging in prohibited transactions, secondary sanctions subject non-U.S. persons to indirect sanctions with different kinds of limitations that can vary from the relatively innocuous (e.g., blocking use of the U.S.’s export-import bank), to the severe (e.g., blocking use of the U.S. financial system or blocking all property interests).

In OFAC’s new regulations and guidance—provided in the form of Frequently Asked Questions (“FAQs”)—the agency notes that it refrained from implementing some portions of the CAATSA sectoral measures.  For example, although CAATSA Section 223(a) authorized the Secretary of Treasury to add “state-owned entit[ies] operating in the railway or metals and mining sector of the economy of the Russian Federation” to the SSI target list, OFAC has not issued such designations to date.[8]  In declining to do so, OFAC noted that CAATSA did not require the imposition of sanctions under Section 223(a), and “maintaining unity” with allies is of critical importance.[9]  Given that it is unlikely that U.S. allies will impose such sanctions we view it as doubtful that this measure will be implemented in the near future.

Directive 1:  Financial Services Sector Sanctions

OFAC did, however, issue an amended Directive 1 on September 29, 2017.[10]  Under the prior version of Directive 1, U.S. persons were prohibited from dealing in new debt of SSI entities in Russia’s financial services sector if the debt had a maturity longer than 30 days.  CAATSA altered Directive 1 by reducing the maximum permitted maturity on new debt from 30 days to 14 days.  This measure significantly tightens the availability of debt financing for SSI-designated Russian financial institutions, but its most significant impact may actually be on how financial institutions interact with SSI entities—even with regard to transactions that do not violate the OFAC prohibitions.  U.S. financial institutions (and the many foreign institutions that regularly choose to comply with OFAC measures) are more likely than ever to closely scrutinize proposed transactions involving SSI entities to make sure that they are in compliance with Directive 1.

Table 1.  Directive 1 Sanctions Effective Dates[11]

Period when the debt was issued

Applicable tenor of prohibited debt

July 16, 2014 to September 12, 2014

Longer than 90 days maturity

September 12, 2014 to November 28, 2017

Longer than 30 days maturity

On or after November 28, 2017

Longer than 14 days maturity

 

Directive 2:  Energy Sector Sanctions

OFAC also issued an amended Directive 2 on September 29, 2017.[12]  Under the prior version of Directive 2, U.S. persons were prohibited from dealing in new debt issued to SSI entities in Russia’s energy sector if that debt had a maturity longer than 90 days.  CAATSA altered Directive 2 by reducing the maximum permitted maturity on new debt from 90 days to 60 days.  This measure further tightens the availability of long-term debt financing for designated entities in Russia’s energy sector.  Here too, we expect U.S. financial institutions (and the many foreign institutions that regularly choose to comply with OFAC measures) to more closely scrutinize proposed transactions involving such entities to make sure that they are in compliance with Directive 2.

Directives 1 and 2 apply to new debt or equity.[13]  OFAC has clarified that “debt” includes bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper.  Debt also includes payment terms—meaning that U.S. persons selling a good or service to an SSI entity need to receive payments within the new debt maturity timeline (an extension of payment of terms is viewed as an extension of credit to the SSI [a “dealing in the new debt” of that entity]).  “Equity” includes stocks, share issuances, depositary receipts, or any other evidence of title or ownership.[14]  The prohibitions extend to rollover of existing debt, if such rollover results in the creation of new debt with the specified maturity periods.[15]  Notably, under section 501.604 of the Reporting, Procedures and Penalties Regulations (31 C.F.R. part 501), U.S. financial institutions must report to OFAC any rejected transactions within 10 business days.[16]  U.S. banks will reject such transactions that exceed the debt maturity limit or consist of new equity.

Table 2.  Directive 2 Sanctions Effective Dates[17]

Period when the debt was issued

Applicable tenor of prohibited debt

July 16, 2014 to November 28, 2017

Longer than 90 days maturity

On or after November 28, 2017

Longer than 60 days maturity

 

Directive 3:  Defense Sector Sanctions

CAATSA made no changes to Directive 3, a provision that was implemented in 2014 to restrict U.S. persons from transacting or dealing in new debt of entities operating in the Russian defense and related materiel sector.  Notably, rather than expanding the scope and impact of sectoral sanctions under Directive 3, in Section 231 (discussed below) CAATSA set forth a series of secondary sanctions that could be imposed against parties that transact with elements of the Russian defense and intelligence sectors.

Table 3.  OFAC Guidance

Type of Activity

OFAC Guidance[18]

Derivative Transactions
  • Permitted.  General License 1A authorizes certain transactions involving derivative products that would otherwise be prohibited pursuant to Directives 1, 2, or 3.[19]  Notably, CAATSA requires the Department of the Treasury to produce a report describing the effects of expanding the Russia sectoral sanctions to “include sovereign debt and the full range of derivative products” by February 2018.[20]
Existing Long-Term Credit Facilities or Loan Agreements
  • Permitted.  If entered into prior to the sanctions effective date, drawdowns and disbursements with repayment terms of 30 days or less (for persons subject to Directives 1 and 3) or 90 days or less (for persons subject to Directive 2) are permitted.[21]
  • Permitted.  Drawdowns and disbursements whose repayment terms exceed the applicable authorized tenor are not prohibited if the terms of such drawdowns and disbursements (including the length of the repayment period, the interest rate applied to the drawdown, and the maximum drawdown amount) were contractually agreed to prior to the sanctions effective date and are not modified on or after the sanctions effective date.
  • Prohibited.  U.S. persons may not deal in a drawdown or disbursement initiated after the sanctions effective date with a repayment term of longer than the authorized tenor, if the terms of the drawdown or disbursement were negotiated on or after the sanctions effective date.  Such a newly negotiated drawdown or disbursement would constitute a prohibited extension of credit.[22]
Letters of Credit
  • Permitted.  U.S. persons may deal in (including act as the advising or confirming bank or as the applicant (i.e., the purchaser of the underlying goods or services)) or process transactions under a letter of credit in which an entity subject to Directive 1, 2, or 3 is the beneficiary (i.e., the exporter or seller of the underlying goods or services) because the subject letter of credit does not represent an extension of credit to the SSI entity.[23]
  • Permitted.  U.S. persons may deal in (including act as the advising or confirming bank or as the applicant or beneficiary) or process transactions under a letter of credit where the issuing bank is an SSI entity provided that the terms of all payment obligations under the letter of credit conform with the debt prohibitions under the applicable Directives.[24]
  • Prohibited.  U.S. persons may not deal in (including act as the advising or confirming bank or as the beneficiary) or process transactions under a letter of credit if all of the following three conditions are met: (1) the letter of credit was issued on or after the sanctions effective date, (2) the letter of credit carries a term of longer than the authorized tenor, and (3) an SSI entity is the applicant of the letter of credit.  This would constitute prohibited activity because the subject letter of credit would represent an extension of credit to the SSI entity.[25]
Debt Involving Non-SSI Entities
  • Permitted.  Directives 1, 2, and 3 do not prohibit U.S. persons from dealing with an SSI entity as counterparty to transactions involving debt issued on or after the sanctions effective date by a non-sanctioned party.  For example, U.S. persons are not prohibited from dealing in a loan exceeding the applicable authorized tenor that is issued after the sanctions effective date of sanctions provided by an SSI entity to a non-sanctioned third-party, dealing with an SSI entity who is the underwriter on new debt of a non-sanctioned third party exceeding the applicable authorized tenor, or accepting payment under a letter of credit with terms exceeding the applicable authorized tenor that is issued, advised, or confirmed by an SSI entity, so long as the SSI entity is not the borrower.[26]
Purchasing Goods or Services from an SSI Entity
  • Permitted.  Directives 1, 2, and 3 do not prohibit U.S. persons from extending credit for longer than the specified tenor to non-sanctioned parties for the purpose of purchasing goods or services from an SSI entity, so long as the SSI entity is not the indirect borrower.[27]
Short-Term Facilities
  • Permitted.  Short-term facilities created after the sanctions effective date are permissible if two conditions are met:  first, as long as each individual disbursement has a maturity within the authorized tenor and the disbursement is paid back in full before the next disbursement and, second, the lender is not contractually required to roll over the balance for a cumulative period of longer than the authorized tenor at the borrower’s request (i.e., it has the option to refuse the request for a new short-term loan and terminate the facility), the loan is not prohibited, even though the same borrower may obtain a series of short-term loans from the same lender over a cumulative period exceeding the authorized tenor.
  • Prohibited.  U.S. persons may not deal in a drawdown or disbursement initiated after the sanctions effective date with a repayment term of longer than the applicable authorized tenor if the terms of the drawdown or disbursement are negotiated or re-negotiated on or after the sanctions effective date, which would be considered a prohibited extension of credit.[28]
Deferred Purchase Payments
  • Prohibited.  Directives 1 and 3 prohibit new extensions of credit to SSI entities of greater than the periods of authorized tenor, and these prohibitions include deferred purchase agreements extending payment terms to an SSI entity.  Such agreements would constitute a prohibited extension of credit to an SSI entity if the terms were longer than the permissible number of days and the agreement was entered into on or after the sanctions effective date.  OFAC does not consider the inclusion of an interest rate to be a necessary condition for establishing whether a transaction represents new debt.[29]

 

Directive 4:  Energy Sector Sanctions

The more significant changes to the Russian sectoral sanctions program are found in CAATSA’s expansion of Directive 4, which was amended by OFAC on October 31, 2017.[30]  The pre-CAATSA Directive 4 prohibited the provision of goods, support, or technology to designated Russian entities relating to the exploration or production for deepwater, Arctic offshore, or shale projects that have the potential to produce oil in the Russian Federation.  Under CAATSA, the expanded Directive 4 removes this geographic limitation and instead targets the new, specified types of projects worldwide in which a designated Russian person has a “controlling interest or a substantial non-controlling ownership interest in such a project defined as not less than a 33 percent interest.”[31]

In issuing the new Directive 4, OFAC staggered the implementation of its broader geographical application.  Effective October 31, 2017, Directive 4 targets projects involving designated persons “that have the potential to produce oil in the Russian Federation, or in maritime area claimed by the Russian Federation and extending from its territory.”  Starting in early 2018, Directive 4 will target new projects anywhere in the world.  Specifically, Directive 4 will extend to projects initiated on or after January 29, 2018, “that have the potential to produce oil in any location, and in which any person determined to be subject to this Directive or any earlier version thereof, their property, or their interests in property have (a) a 33 percent or greater ownership interest, or (b) ownership of a majority of the voting interests.”  This means that the new Directive 4 will not require U.S. energy businesses already engaged in projects that could be covered to divest from such projects.

This grandfathering of certain energy projects is in line with prior U.S. sanctions in the Iran context.  For example, OFAC exempted the Caspian Sea Shah Deniz oil project despite the involvement of Iranian parties.[32]  In this case, the specific projects are unnamed but we believe that projects critical to the energy security of our European and Asian allies—in which Russian firms play important roles—are the intended beneficiaries of this exception.

Note that the prohibition of subsection 2 of Directive 4 applies to projects owned 33 percent or more in the aggregate by one or more Directive 4 SSI entities, their property, and their interests in property, including entities owned 50 percent or more by one or more persons determined to be subject to Directive 4.  The prohibition also applies to projects in which one or more Directive 4 SSI entities, their property, or their interests in property own an aggregated majority of the voting interests.  Accordingly, if two SSI entities listed under Directive 4 each hold a 20 percent ownership interest in Project X, or together own a majority of the voting interests in the project, then the prohibition of subsection 2 of Directive 4 applies to Project X.[33]

OFAC offered the following three examples to clarify how Directive 4 applies to projects in which a designated person owns a 33 percent or more interest:

  • Example 1: An SSI entity listed under Directive 4 (“Entity A”) has a 33 percent ownership interest in a deepwater, Arctic offshore, or shale project initiated on or after January 29, 2018 that has the potential to produce oil (“Project X”). The prohibition of subsection 2 of Directive 4 applies to Project X. Consequently, U.S. persons are prohibited from providing goods, services (except for financial services), or technology in support of exploration or production for Project X.
  • Example 2: Instead of holding a direct interest in Project X, Entity A now owns 50 percent of Entity B, and Entity B holds a 33 percent interest in Project X. As a result of OFAC’s 50 percent rule, Entity B is subject to Directive 4. Because Entity B is subject to Directive 4 and owns a 33 percent or greater interest in Project X, the prohibition of subsection 2 of Directive 4 applies to Project X. Consequently, U.S. persons are prohibited from providing goods, services (except for financial services), or technology in support of exploration or production for Project X.
  • Example 3: Entity A now owns only 33 percent of Entity B, and Entity A is the only SSI entity that owns any interest in Entity B. Entity B holds a 100 percent ownership interest in Project X. Entity A owns less than 50 percent of Entity B, and so, in accordance with the 50 percent rule, Entity B is not subject to Directive 4. The prohibition of subsection 2 of Directive 4 would therefore not apply to Project X, even though Entity B owns an interest in the project that is 33 percent or greater.

Several FAQs clarify key points in the changes:

  • Types of Prohibited Services:  As set forth in the new FAQs, the prohibitions on the exportation of services under Directive 4 include, for example, drilling services, geophysical services, geological services, logistical services, management services, modeling capabilities, and mapping technologies.  The prohibitions do not apply to the provision of financial services, e.g., clearing transactions or providing insurance related to such activities.[34]
  • Application to Oil and Gas Projects:  OFAC also clarified that if a deepwater, Arctic offshore, or shale project has the potential to produce oil, and the other requirements for either of the Directive 4 prohibitions are fully satisfied, then the relevant Directive 4 prohibition applies irrespective of whether the project also has the potential to produce gas.  If the project has the potential to produce gas only, then the Directive 4 prohibitions do not apply.[35] 
  • Shale Projects, Defined:  OFAC interprets the term “shale projects” to include projects that have the potential to produce oil from resources located in shale formations.  Therefore, as long as the projects in question are neither deepwater nor Arctic offshore projects, the prohibitions in Directive 4 do not apply to exploration or production through shale to locate or extract crude oil (or gas) in reservoirs.[36] 
  • Arctic Offshore Projects, Defined:  The term “Arctic offshore projects” applies to projects that have the potential to produce oil in areas that (1) involve drilling operations originating offshore, and (2) are located above the Arctic Circle.  The prohibitions do not apply to horizontal drilling operations originating onshore where such drilling operations extend under the seabed to areas above the Arctic Circle.[37]
  • When Is A Project “Initiated”?:  For purposes of the global prohibitions effective January 29, 2018, a project is “initiated” when a government or any of its political subdivisions, agencies, or instrumentalities (including any entity owned or controlled directly or indirectly by any of the foregoing) formally grants exploration, development, or production rights to any party.[38] As discussed above, this grandfathering of existing projects—even those that have only just been launched and are perhaps years away from producing oil—is a significant exception.
  • Subsidiaries:  OFAC clarified that prohibitions imposed pursuant to the new Directives extend to “entities owned 50 percent or more by one or more persons identified as subject to the Directives.”  Notably, this means that Directive 4 extends to projects in which 50 percent-owned subsidiaries have a 33 percent ownership interest.[39]

II.  Secondary Sanctions

Amendments to the Ukraine Freedom Support Act of 2014

CAATSA Sections 225 and 226 amend portions of the Ukraine Freedom Support Act of 2014 by making many of the sanctions in that law, which were previously discretionary and which President Obama chose not to implement, mandatory.[40]  However, as with other parts of CAATSA, there are several ways that the President can comply with Sections 225 and 226 and still opt not to impose these mandatory measures.

Section 226 focuses on global financial institutions and makes mandatory 22 U.S.C. § 8924 (a), which had previously provided that the President “may impose” sanctions against foreign financial institutions (“FFIs”) that “knowingly engage[] . . . in significant transaction[s] involving” a person sanctioned under section 8923 for either (a) the transfer into Syria of defense articles, (b) the development of Russian Special Crude Oil Projects, or (c) Gazprom’s “withholding significant natural gas supplies” from NATO, Ukraine, Georgia, or Moldova.[41]  The law now requires the President to impose such measures (the President “shall impose”).  Section 226 also amended section 8924 (b), which authorized the President to impose sanctions on FFIs that “knowingly facilitate a significant financial transaction on behalf of any Russian person” on the SDN List pursuant to the Ukraine Freedom Support Act or the Ukraine-specific executive orders.[42]  The sanction authorized under section 8924 is a prohibition on the use of a correspondent account in the United States.[43]  Here too, the law now provides that the President “shall impose” such sanctions.

However, as in so much of CAATSA, the President can opt not to impose these “mandatory” measures if he “determines that it is not in the national interest of the United States to do so.”

Adding to this option for flexibility, on October 31, 2017, OFAC issued an FAQ to further clarify the scope of sanctions that FFIs could face under Section 226.[44]  OFAC confirmed that FFIs will not be subject to sanctions “solely on the basis of knowingly facilitating significant financial transactions” on behalf of SSI entities.[45]  The FAQ also notes that, “[u]nless the Secretary of State makes a determination that it is not in the national interest of the United States to do so, the Secretary of the Treasury shall prohibit the opening and prohibit or impose strict conditions on the maintaining in the United States of correspondent accounts or payable-through accounts for any FFI that the Secretary of the Treasury, in consultation with the Secretary of State, determines has engaged in sanctionable activity.”[46]  If Treasury decides to impose such measures, it will add the name of the FFI to a list similar to the List of Foreign Financial Institutions Subject to Part 561 (the “Part 561 List”).[47]  Treasury will establish and publicize that list before adding any FFIs to it.[48]

For purposes of implementing Section 226 of CAATSA, OFAC will consider the “totality of the facts and circumstances” when determining whether transactions or financial transactions are “significant.”  Importing its definition from the Iran sanctions context,[49] OFAC notes that it will consider the following list of seven broad factors in determining whether a transaction is “significant”:

1) the size, number, and frequency of the transaction(s);

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 that the Secretary of the Treasury deems relevant on a case-by-case basis.[50]

OFAC provides itself even greater discretion through the substantial breadth of multi-factor inquiries.

In line with other sanctions programs, OFAC will generally interpret the term “financial transaction” broadly to encompass any transfer of value involving a financial institution.  For example, the following is a non-exhaustive list of activities that OFAC would consider to be a “financial transaction”:

  • receipt or origination of wire transfers;
  • acceptance of commercial paper (both retail and wholesale), and the clearance of such paper (including checks and similar drafts);
  • receipt or origination of ACH or ATM transactions;
  • holding of nostro, vostro, or loro accounts;
  • provision of trade finance or letter of credit services;
  • provision of guarantees or similar instruments;
  • provision of investment products or instruments or participation in investments; and
  • any other transactions for or on behalf of, directly or indirectly, a person serving as a correspondent, respondent, or beneficiary.[51]

Also in accord with other programs, OFAC noted that it will generally interpret the term “facilitated” broadly to refer to the “provision of assistance for certain efforts, activities, or transactions, including the provision of currency, financial instruments, securities, or any other transmission of value; purchasing; selling; transporting; swapping; brokering; financing; approving; guaranteeing; the provision of other services of any kind; the provision of personnel; or the provision of software, technology, or goods of any kind.”[52]

Section 228: “Foreign Sanctions Evaders” and “Serious Human Rights Abusers”

Section 228, which became effective upon CAATSA’s enactment in August 2017, seeks to impose sanctions on transactions with persons that “evade sanctions imposed with respect to the Russian Federation,” and “persons responsible for human rights abuses.”  Congress drafted Section 228 very broadly, however, and in its plain text appeared to potentially make sanctionable almost any transaction with any entity—SDN or SSI—listed under Russia sanctions.  The OFAC guidance provides some important limitations on this impact.

Specifically, section 228 requires the President to impose sanctions on a foreign person who knowingly “materially violates, attempts to violate, conspires to violate, or causes a violation of” applicable sanctions against Russia, or that “facilitates a significant transaction, including deceptive or structured transactions, for or on behalf of any person subject to sanctions imposed by the United States with respect to the Russian Federation,” or any child, spouse, parent, or sibling of the same.[53] (emphases added).  The language did not specify whether the “person subject to sanctions” must be an SDN or could be an SSI.  In October, OFAC clarified that this provision extends to persons listed on either the SDN or SSI List, as well as persons subject to sanctions pursuant to OFAC’s 50 percent rule.[54]

However, if Section 228 were implemented as drafted, the difference between SDN and SSI designations could have disappeared—secondary sanctions could have been imposed in response to identical dealings with an SDN or an SSI, including even those transactions with SSIs that are permitted (namely all transactions other than the specific debt and equity prohibitions noted in the Directives).

In its implementing guidance, OFAC confirmed that Section 228 extends to SDNs and SSI entities but clarified that it would not deem a transaction “significant” if U.S. persons could engage in the transaction without the need for a specific license from OFAC.  In other words, only transactions prohibited by OFAC—specifically, transactions with SDNs and/or transactions with SSI entities that are prohibited by the sectoral sanctions—will “count” as significant for purposes of Section 228.  OFAC also noted that even a transaction with an SSI that involves prohibited debt or equity would not automatically be deemed “significant”—it would need to also involve “deceptive practices” and OFAC would assess this criteria on a “totality of the circumstances” basis.

The conclusion from Section 228’s guidance is that despite the provision’s seeming breadth, the status quo under which most international financial institutions have been operating ever since the advent of SSIs in 2014 remains: transactions with SDNs are risky; transactions with SSIs are much less so.

OFAC noted that it anticipates that “regulations to be promulgated will generally reflect the following” key definitions:

Key Term

OFAC Definition or Guidance

Facilitation
  • For purposes of section 10(a)(2) of the Support for the Sovereignty, Integrity, Democracy, and Economic Security of Ukraine Act of 2014, (“SSIDES”), facilitating a significant transaction for or on behalf of a person will be interpreted to mean providing assistance for a transaction from which the person in question derives a particular benefit of any kind (as opposed to a generalized benefit conferred upon undifferentiated persons in aggregate). Assistance may include the provision or transmission of currency, financial instruments, securities, or any other value; purchasing, selling, transporting, swapping, brokering, financing, approving, or guaranteeing; the provision of other services of any kind; the provision of personnel; or the provision of software, technology, or goods of any kind.[55]
Significant Transaction
  • For purposes of section 10(a)(2) of SSIDES, OFAC will consider the “totality of the facts and circumstances” when determining whether transactions are “significant.”
  • Furthermore, for purposes of section 10(a)(2) of SSIDES, a transaction is not significant if U.S. persons would not require specific licenses from OFAC to participate in it.
  • A transaction in which the person(s) subject to sanctions is only identified on the SSI List must also involve deceptive practices (i.e., attempts to obscure or conceal the actual parties or true nature of the transaction(s), or to evade sanctions) to potentially be considered significant.
  • A transaction involving an SSI entity is not, however, automatically significant simply because a U.S. person would require a specific license from OFAC to participate in it and it involves deceptive practices.  In all cases, OFAC explains that the totality of the circumstances, including the other factors listed above, will shape the final determination of significance.[56]
Deceptive or Structured Transaction
  • As indicated in section 10(f)(3) of SSIDES as added by CAATSA, the term “structured” is defined in 31 C.F.R. § 1010.100(xx). Structured transactions are a type of deceptive transaction. A “deceptive transaction” is one that involves deceptive practices. As described in 31 C.F.R. § 561.404(f), “deceptive practices” are attempts to obscure or conceal the actual parties or true nature of a transaction, or to evade sanctions.[57]
Materially Violate
  • For purposes of section 10(a)(1) of SSIDES, OFAC will interpret the term “materially violate” to refer to an “egregious” violation.  A determination about whether a violation is egregious will be based on an analysis of the applicable General Factors as described in OFAC’s Economic Sanctions Enforcement Guidelines, located in subsection (B)(1), section V of Appendix A to 31 C.F.R. part 501.[58]

Section 231:  Intelligence and Defense Sectors

Section 231(a) provides that the President shall impose secondary sanctions with respect to a person the President determines knowingly “engages in a significant transaction with a person that is part of, or operates for or on behalf of, the defense or intelligence sectors of the Government of the Russian Federation, including the Main Intelligence Agency of the General Staff of the Armed Forces of the Russian Federation or the Federal Security Service of the Russian Federation.”  On October 27, 2017, the State Department issued a list of almost 40 entities subject to the law.[59]

There are several unique components to Section 231.  First, it is a secondary sanctions provision that covers both U.S. and non-U.S. persons.  Historically, secondary sanctions have only addressed non-U.S. persons and were consciously structured to bring transactions otherwise outside U.S. jurisdiction into compliance with U.S. policy.  The reason this expansion of secondary sanctions was necessary in this case is due to another unique feature of secondary sanctions under Section 231: in all other implementations of secondary sanctions the risk of such measures being imposed came from a non-U.S. person transacting with an SDN or an entity identified as owned or controlled by an SDN, or specific entities under the jurisdiction of sanctioned governments. That is not the situation here—the State Department explicitly noted that an entity’s inclusion on the list of Section 231 entities does not mean that an entity is sanctioned.  Though some entities on the list are SDNs or SSIs, the vast majority are neither.  Because of this, if the secondary sanctions had not been expanded to include U.S. persons a counterintuitive outcome could have resulted in which a U.S. person could engage in transactions with Section 231 parties (because they were neither SDNs nor SSIs) and non-U.S. persons could not.

As discussed above, the secondary sanctions imposed under this section do not impact subsidiaries owned 50 percent or more by a designated entity, and the CAATSA designations list contains numerous subsidiaries and affiliates of entities that had previously been listed under other provisions of the Russia sanctions, like Directive 3.  That means that unless they are listed elsewhere (such as on the SSI list), U.S. and non-U.S. persons may continue to deal with the unlisted subsidiaries of entities on the Section 231 list.

Furthermore, the measures that could be imposed under Section 231 are discretionary in nature.  The language of the legislation is somewhat misleading in this regard.  Section 231 is written as a mandatory requirement—providing that the President “shall impose” various restrictions. However, the legislation itself—and the October 27, 2017 guidance provided by the State Department—makes it clear that there are several tripwires that the President must determine have been crossed by an offending party before any secondary sanctions are even considered.  Under Section 231, secondary sanctions are only imposed after the President makes a determination that a party “knowingly” engaged in “significant” transactions with a listed party.  These terms (“knowingly” and “significant”) have imprecise meanings (even under the guidance).  Of note, the State Department provides that if a transaction for goods or services has purely civilian end-uses and/or civilian end-users, and does not involve entities in the intelligence sector, these factors will generally weigh heavily against a determination that such a transaction is significant for purposes of Section 231.[60]  This is critical because many U.S. allies rely on several of the entities on the Section 231 list for civilian products and services (such as commercial aircraft).  In short, if the President wants to avoid finding against an entity under Section 231 he has substantial ability to do so.

Another component of the President’s built-in discretion—which is hinted at in the State Department guidance—is that because secondary sanctions are not usually “blocking” (or freezing) sanctions, as a matter of practice the U.S. government will only impose them after providing a party the opportunity to cure any problem. Parties, before being sanctioned under secondary measures, are almost always warned to change their behavior—and only if their behavior does not change are secondary sanctions imposed. Secondary sanctions, even more than primary sanctions, are designed to change behavior rather than punish for past wrongdoing.

What is a “significant” transaction for purposes of Section 231?

  • Totality of the Facts and Circumstances. The State Department guidance indicates that it “will consider the totality of the facts and circumstances surrounding the transaction and weigh various factors on a case-by-case basis.” Factors to be considered in the determination may include, but are not limited to, the significance of the transaction to U.S. national security and foreign policy interests, in particular whether it has a significant adverse impact on such interests; the nature and magnitude of the transaction; and the relation and significance of the transaction to the defense or intelligence sector of the Russian government.
  • Civilian End-Uses or Users. The State Department indicated that, in this initial implementation stage, the U.S. government focus is expected to be on “significant transactions of a defense or intelligence nature with persons named in the Guidance,” and if a transaction for goods or services has “purely civilian end-uses and/or civilian end-users, and does not involve entities in the intelligence sector, these factors will generally weigh heavily against a determination that such a transaction is significant for purposes of Section 231.”
  • Federal Security Service (“FSS”). Similarly, if a transaction is necessary to comply with rules and regulations administered by the FSS, or law enforcement or administrative actions or investigations involving the FSS, then “these factors will weigh heavily against a determination that such transaction is significant.”

Section 232: Russian Energy Export Pipelines 

CAATSA section 232 gives the President the authority to impose certain sanctions targeting Russian energy export pipelines.  Notably, the President is not required to impose the sanctions described in section 232.  Indeed, his doing so may be unlikely due to the qualifier that such sanctions are to be imposed “in coordination with allies of the United States.”  Given their reliance on Russian energy, European allies, in particular, have been very public in their objection to this section of CAATSA in particular.[62]  It is highly unlikely that any would follow (let alone lead) sanctions efforts on Russian energy pipelines.

Section 233:  Privatization of State-Owned Assets

Section 233 requires the President to impose sanctions on any person (U.S. or non-U.S.) that, with actual knowledge, makes an investment of $10,000,000 or more, or facilitates such an investment, if the investment directly contributes to the ability of Russia to privatize state-owned assets in a manner that unjustly benefits Russian government officials or their families.  As with section 232, if the President determined that a person violated section 233’s provisions, he would be required to impose at least five of 12 possible sanctions described in section 235.

This mandatory sanctions provision takes effect from the date of enactment of CRIEEA (i.e., August 2, 2017).  As in Section 231 above, by using “person” rather than “foreign person” or “U.S. person,” Congress signaled that it intended for the sanctions to be applied to both U.S. and non-U.S. persons engaged in the prohibited investments.  The likelihood of imposing sanctions in this regard is also reduced given the requirement that OFAC will need to determine that such an investment “unjustly” benefits Russian government officials or their families.  We assess that “unjust” likely is meant to imply “corrupt” and corruption is a very challenging basis on which to impose sanctions.  OFAC has historically been very reticent to do so.  Indeed, very few sanctions programs have included a corruption basis and there are only a handful of actual designations OFAC has promulgated on this basis.  That there is no definition of “unjustly” underscores the unlikeliness of the Administration imposing sanctions under this measure.

Key Term

OFAC Definition or Guidance

Investment
  • OFAC will interpret the term “investment” broadly as a transaction that constitutes a commitment or contribution of funds or other assets or a loan or other extension of credit to an enterprise. For purposes of this interpretation, a loan or extension of credit is any transfer or extension of funds or credit on the basis of an obligation to repay, or any assumption or guarantee of the obligation of another to repay an extension of funds or credit, including: overdrafts, currency swaps, purchases of debt securities issued by the Government of Russia, purchases of a loan made by another person, sales of financial assets subject to an agreement to repurchase, renewals or refinancings whereby funds or credits are transferred or extended to a borrower or recipient described in the provision, the issuance of standby letters of credit, and drawdowns on existing lines of credit.[63]
Facilitates
  • For purposes of implementing section 233 of CAATSA, OFAC will interpret “facilitates” to mean the provision of assistance for certain efforts, activities, or transactions, including the provision of currency, financial instruments, securities, or any other transmission of value; purchasing, selling, transporting, swapping, brokering, financing, approving, or guaranteeing; the provision of other services of any kind; the provision of personnel; or the provision of software, technology, or goods of any kind.[64] 
Unjustly Benefits
  • OFAC will interpret the term “unjustly benefits” broadly to refer to activities such as public corruption that result in any direct or indirect advantage, value, or gain, whether the benefit is tangible or intangible, by officials of the Government of the Russian Federation, or their close associates or family members. Such public corruption could include, among other things, the misuse of Russian public assets or the misuse of public authority.[65]
Close Associates or Family Members
  • OFAC will interpret the term “close associate” of an official of the Government of the Russian Federation as a person who is widely or publicly known, or is actually known by the relevant person engaging in the conduct in question, to maintain a close relationship with that official. OFAC will interpret the term “family member” of an official of the Government of the Russian Federation to include parents, spouses (current and former), extramarital partners, children, siblings, uncles, aunts, grandparents, grandchildren, first cousins, stepchildren, stepsiblings, parents-in-law, and spouses of any of the foregoing.[66]

 


   [1]   Pub. L. No. 115-44 (2017).

   [2]   See Statement by President Donald J. Trump on Signing the “Countering America’s Adversaries Through Sanctions Act” (August 2, 2017), available at https://www.whitehouse.gov/the-press-office/2017/08/02/statement-president-donald-j-trump-signing-countering-americas.

   [3]   E.O. No. 13662 (79 Fed. Reg. 16169) Blocking Property of Additional Persons Contributing to the Situation in Ukraine (March 24, 2014); CAATSA Section 222 (codification), 223 (expansion).

   [4]   See Sections 223, 231.  A list of the secondary sanctions that could be imposed pursuant to CAATSA is provided in Section 235.  This list borrows from prior sanctions programs and includes a menu of prohibitions ranging from denying assistance from the U.S. Export-Import Bank and limiting export authorizations, to freezing assets and imposing sanctions on principal executive officers of an offending organization.

   [5]   E.O. No. 13662 (79 Fed. Reg. 16169) Blocking Property of Additional Persons Contributing to the Situation in Ukraine (March 24, 2014); CAATSA Section 222 (codification), 223 (expansion).

   [6]   OFAC maintains an updated list of the entities designated pursuant to each Directive in PDF, text, or a searchable list format at https://www.treasury.gov/resource-center/sanctions/SDN-List/Pages/ssi_list.aspx.

   [7]   OFAC Ukraine-/Russia-related Sanctions FAQs (“OFAC FAQs”), FAQ No. 373, available at https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_other.aspx#ukraine.

   [8]   OFAC FAQ No. 539.

   [9]   Id.  (“Section 223(a) of CAATSA does not require the imposition of sanctions. While sanctions may be imposed on potential targets in any sector of the economy of the Russian Federation in the future, maintaining unity with partners on sanctions implemented with respect to the Russian Federation is important to the U.S. government. The point of the sectoral sanctions is to impose costs on the Russian Federation for its aggression in Ukraine. The United States will continue to work closely with our allies to address unintended consequences arising as a result of such sanctions.”)

[10]   OFAC, Directive 1 (as amended on September 29, 2017) under Executive Order 13662, available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/eo13662_directive1_20170929.pdf.

[11]   OFAC FAQ No. 370.

[12]   OFAC, Directive 2 (as amended on September 29, 2017) under Executive Order 13662, available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/eo13662_directive2_20170929.pdf.

[13]   OFAC FAQ No. 371.

[14]   Id.

[15]   Id.

[16]   OFAC FAQ No. 370.  31 C.F.R. §501.604(a) provides that “any financial institution that rejects a funds transfer where the funds are not blocked under the provisions of this chapter, but where processing the transfer would nonetheless violate, or facilitate an underlying transaction that is prohibited under, other provisions contained in this chapter, must report.”

[17]   Id.

[18]   OFAC FAQ No. 394.  On September 29, 2017, OFAC amended and reissued Directives 1 and 2 in accordance with Sections 223(b) and (c) of CRIEEA.  While the Directives are effective immediately, both Directives contain certain new prohibitions that will not come into effect until November 28, 2017, pursuant to CRIEEA.  In addition to these new prohibitions, the Directives continue to prohibit conduct that was prohibited by prior versions of the Directives.  OFAC plans to issue further guidance regarding the implementation of the new prohibitions in the Directives at a later date, including updating relevant FAQs to account for the new prohibitions that will come into effect on November 28, 2017.

[19]   OFAC, General License 1A (September 12, 2014), available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/ukraine_gl1a.pdf; OFAC FAQ No. 372.

[20]   CAATSA Section 242.

[21]   OFAC FAQ No. 394.

[22]   Id.

[23]   OFAC FAQ No. 395.

[24]   Id.

[25]   Id.

[26]   OFAC FAQ No. 405.

[27]   OFAC FAQ No. 408.

[28]   OFAC FAQ No. 409.

[29]   OFAC FAQ No. 410.

[30]   OFAC, Directive 4 (as amended on October 31, 2017) under Executive Order 13662, available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/eo13662_directive4_20171031.pdf.

[31]   Id. § 223(d).

[32]   See OFAC, Industry Guidance – Shah Deniz Consortium (November 28, 2012),available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/shah_deniz_guidance.pdf.

[33]   OFAC FAQ No. 538.

[34]   OFAC FAQ No. 412.

[35]   OFAC FAQ No. 414.

[36]   OFAC FAQ No. 418.

[37]   OFAC FAQ No. 421.

[38]   OFAC FAQ No. 536.

[39]   OFAC FAQ No. 373.

[40]   22 U.S.C. § 8924(a) and (b).  The pre-CAATSA version of 22 U.S.C. § 8923 provided that the President “may impose” sanctions on foreign persons that knowingly make a “significant investment” in a “special Russian crude oil project.”  Similarly, the pre-CAATSA version of section 8924(a) provided that the President “may impose” sanctions against foreign financial institutions that “knowingly enage[] . . . in significant transaction[s] involving” a person sanctioned under § 8923 for either (a) the transfer into Syria of defense articles, (b) the development of Special Crude Oil Projects, or (c) Gazprom’s “withholding significant natural gas supplies” from NATO, Ukraine, Georgia, or Moldova.  Furthermore, the pre-CAATSA section 8924(b) authorized the President to impose sanctions on foreign financial institutions that “knowingly facilitated a significant financial transaction on behalf of any Russian person” on the SDN List pursuant to the Ukraine Freedom Support Act or the Ukraine-specific executive orders.

[41]   See § 8924, referencing § 8923(a)(2) (Syria); § 8923(b)(1) (Russia crude oil projects) and § 8923(b)(3) (Gazprom withholding of natural gas supplies from NATO, Ukraine, Georgia or Moldova).

[42]   22 U.S.C. § 8924(b) and (c).

[43]   22 U.S.C. § 8924(c).

[44]   OFAC FAQ No. 541.

[45]   Id.

[46]   Id.

[47]   OFAC FAQ No. 543.

[48]   Id.  The list will be included in the Consolidated Sanctions List Data Files, and will be available for download in all Consolidated Sanctions List data file formats.

 [49]   See Iran-Related FAQs, Question No. 174; see also Iran-Related FAQ Question 154, which offers a slightly different list of factors to explain how the Treasury Department will determine whether a transaction or financial service is “significant” for purposes of the Iranian Financial Sanctions Regulations:  “(1) the size, number, frequency, and nature of the transaction(s); (2) the level of awareness of management of the transaction(s) and whether or not the transaction(s) are a part of a pattern of conduct; (3) the nexus between the foreign financial institution involved in the transaction(s) and a blocked Islamic Revolutionary Guard Corps individual or entity or blocked Iran-linked financial institution; (4) the impact of the transaction(s) on the goals of CISADA; (5) whether the transaction(s) involved any deceptive practices; and (6) other factors the Treasury Department deems relevant on a case-by-case basis.”

[50]   OFAC FAQ No. 542.

[51]   Id.

[52]   Id.

[53]   CRIEEA §228 (a)

[54]   OFAC FAQ No. 546.

[55]   OFAC FAQ No. 545.

[56]   Id.

[57]   Id.

[58]   Id.

[59]   U.S. State Department, CAATSA Section 231(d) Defense and Intelligence Sectors of the Government of the Russian Federation (October 27, 2017), available at https://www.state.gov/t/isn/caatsa/index.htm.

[60]   See U.S. State Department, Public Guidance/FAQ, Public Guidance on Sanctions with Respect to Russia’s Defense and Intelligence Sectors Under Section 231 of the Countering America’s Adversaries Through Sanctions Act of 2017 (October 27, 2017), available at https://www.state.gov/t/isn/caatsa/275118.htm.

[61]   Id.  (“The Guidance names certain persons, but it is not a determination regarding imposition of sanctions. No asset freezes are being imposed on these named persons as a result of their inclusion in this Guidance, and inclusion in this Guidance does not, of itself, mean such persons are added” to the SDN or SSI Lists.).  “Blocking” sanctions require asset freezing; if an entity was warned that its assets would be frozen there would be immediate asset flight which would dull the impact of the measure.

[62]   See Christian Krug and Kalina Oroschakoff, Germany and Austria warn US over expanded Russia sanctions, Politico, (June 15, 2017), available at https://www.politico.eu/article/germany-and-austria-warn-u-s-over-expanded-russia-sanctions/.

[63]   OFAC FAQ No. 540.

[64]   Id.

[65]   Id.

[66]   Id.


The following Gibson Dunn lawyers assisted in preparing this client update: Adam Smith, Judith Alison Lee, Caroline Krass, Christopher Timura, Stephanie Connor, and Henry Phillips.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade Group:

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