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The Office of Foreign Assets Control recently designated 7 “oligarchs,” 17 government officials, 13 companies, and one bank, all Russian, as Specially Designated Nationals (SDNs), effectively prohibiting US persons (individuals and entities) from any dealings with these SDNs, as well as with entities with 50% or more SDN ownership. Fund investors should be proactive in identifying holdings in blocked entities to avoid inadvertently ending up with interests in blocked assets and the accompanying reporting requirements.

The Executive Orders (EOs) governing these designations (EO 13661 and EO 13662), in addition to prohibiting any “dealings,” also require that US persons “block” any assets of the SDNs under the US persons’ control, to the extent that those assets are subject to US jurisdiction. This mandate effectively prohibits any US person from trading in the securities of the blocked entities or receiving any payments or proceeds from them.

The designations involve a number of publicly traded companies whose securities are somewhat widely held. As such, concurrent with the designations, the Office of Foreign Assets Control (OFAC) issued General License 13¹ (GL13), which provides parties holding assets subject to the sanctions (i.e., equities, bonds, and other securities) until 12:01 am EST May 7, 2018, to divest those assets.

Wide array of investment holdings impacted

This new round of designations will affect a broad swath of investment holdings, especially when compared to previous Russia sanction actions by the US government. OFAC’s prior Russia sanctions largely designated entities under so-called "sectoral sanctions," which prohibit certain specified dealings with sanctioned entities (for example, a ban on the creation of new debt with a maturity greater than 14 days). Under the recent sanctions, however, all types of activities are prohibited—SDNs are completely cut off from any dealings with US persons.

Moreover, pursuant to OFAC’s “50% Rule,” if one or more SDNs individually or collectively hold 50% or more of the ownership in an entity, it must be treated as an SDN, even if it has not been named by OFAC. For example, if two named oligarchs collectively own 50% or more of a company’s stock (wherever located), that company is an SDN for sanctions purposes, and US persons are prohibited from transactions with that entity.

Wind-down period for certain entities

GL13 authorises US persons holding stock, debt, or other securities in certain specifically identified sanctioned parties — namely, EN+ Group PLC, GAZ Group, and United Company RUSAL PLC — to divest those holdings on or before May 7, 2018. If such divestiture is not completed before May 7, GL13 is no longer available, and any further dealings will require OFAC authorisation. Moreover, if securities are not divested, then the party holding those securities must block the assets, which includes (1) depositing any funds received from the assets into a blocked interest-bearing account and (2) filing an initial report with OFAC regarding the assets and annual reports every September 30 until the sanctions are lifted.

While GL13 names the specific entities to which it applies, it is silent regarding its applicability to entities (if any) with SDN ownership of 50% or more, and thus the wind-down opportunity is not available for those companies. Therefore, for entities not specifically named in GL13 — including, from all appearances, those that are SDNs because they have SDN ownership of 50% or more — the assets are immediately blocked (i.e., starting on April 6).

Questions raised by OFAC’s actions

OFAC’s actions do not answer a number of important questions, and investors and fund managers therefore will need to be proactive and cautious in their own actions. Some general questions and considerations include the following:

• Is the May 7 divestiture deadline met if the trade is executed but not settled? 

This question is not addressed by OFAC, and thus the prudent course of action would be to ensure that the transaction is settled by the deadline to avoid an interpretation that a party is otherwise “transacting” in the securities after 12:01 am on May 7.

• If a fund includes US investors but is located outside the United States, must it divest otherwise blocked assets, and if it does not, will it be subject to OFAC jurisdiction? 

In the past, OFAC has taken the position that the use of US money to engage in sanctionable activity constitutes a form of facilitation. As a result, fund managers generally will be faced with a choice to either segregate (or remove) US parties from funds that hold securities in SDN entities, or divest the securities. From recent market activity, it appears that most are electing to divest the securities. Of course, the fund managers need to consider their own nexus to the United States as well, as they may be directly subject to OFAC jurisdiction.

• If a fund does not divest SDN securities, what are its and its investors’ continuing obligations? 

If the fund includes US monies, or the fund is independently subject to OFAC jurisdiction, and it does not take advantage of the May 7 wind-down deadline to divest SDN securities, then it will need to immediately block the securities. EOs 13661 and 13662 and OFAC regulations describe the additional steps necessary once assets are blocked. See 31 CFR 500.501. Those steps include filing a report within 10 business days of blocking the asset², creating a proper blocking account (with specific interest-bearing requirements), and filing annual reports every September 30. See 31 CFR 500.603(b) (2). Reporting is required until the entity is no longer an SDN and the assets are no longer blocked, which could be years.

• Do the fund formation documents require a particular course of action or any specific notices? 

This decision will be fund-specific, but many fund documents that involve US investors include OFAC compliance covenants, and some may include redemption rights for investors that wish to exit the fund that seeks to retain the SDN securities.

Investor considerations

Some additional considerations from an investor perspective:

• Investors in funds may need to be proactive to avoid ending up with an interest in blocked assets and being subject to the accompanying reporting requirements. OFAC likely would interpret certain investor activities as “facilitating” or benefitting from SDN securities in overseas funds. Thus, investors should proactively make inquiries to third-party managers to determine whether any SDN securities are in the fund’s portfolio. Since OFAC defines “securities” broadly, this would include non-stock equity and/or debt.
• If a fund has any interest in affected securities, the investor should communicate with the fund manager to determine whether divestiture prior to May 7 is planned and, if so, should also follow up and obtain confirmation that divestiture has occurred.
• If a fund does not intend to divest, or for any reason does not actually divest, the investor may seek to exit the fund (prior to May 7) or even obtain a license to do so after May 7, subject to fund participation requirements.
• Investors should examine whether OFAC’s reporting obligations flow down to individual investors, either via the fund documents or as a legal matter. This could depend upon many factors, including how distributions occur and how accounting is handled. If funds from SDN securities are distributed to investors, then those funds likely would become blocked immediately upon receipt, and the related reporting and blocking requirements could, for example, apply each time a dividend is paid.
• Investor obligations may arise simply from being a part of the fund that holds blocked assets. This is a question that may need direct input from OFAC given that every situation can be unique.
• Once the SDN securities are blocked (post-May 7), affected investors should consider whether fund disposition of those securities constitutes an action that requires OFAC authorisation and, if so, whether the investor should play a proactive role in ensuring that unauthorised divestitures do not occur.
• Investors that stay in funds holding SDN securities also may wish to examine whether inadvertently receiving funds in the form of dividends or other payments constitutes a payment from an SDN, which would violate the regulations.
• OFAC likely will expect managers to at least inquire concerning the status and ownership of SDN securities. Investors in funds may wish to request an update from fund managers as to whether any investments in SDN securities or businesses now exist, and confirm that the fund managers have addressed the 50% Rule in their analysis. If the answer is yes, investors should request an immediate plan for divestiture and determine whether the investor has independent reporting responsibilities or the ability to withdraw from the fund.
• Non-US investors in particular should be aware of potential liabilities pursuant to the Countering America’s Adversaries Through Sanctions Act (Pub. L. 115-44), sections of which potentially subject non-US persons to sanctions for knowingly facilitating “significant transactions” for or on behalf of blocked individuals or entities.

Kenneth J. Nunnenkamp has more than 30 years of litigation and investigation experience, including time as a JAG Officer in the US Marine Corps, Ken routinely conducts internal investigations for clients, including investigations into actual or potential compliance issues arising under the International Traffic in Arms Regulations (ITAR), Export Administration Regulations (EAR), Office of Foreign Assets Controls Regulations, US Customs Regulations, and Foreign Trade Regulations. Additionally, Ken works with clients to understand each business’s scope and needs in establishing and improving trade and sanctions compliance programs, including the creation and auditing of company export management systems of all sizes. Ken is leading the Morgan Lewis CFIUS working group.

Giovanna M. Cinelli is the leader of the Firm’s international trade and national security practice. As a practitioner for more than 30 years, she counsels clients in  the defense, aerospace and high technology sectors on a broad range of issues affecting national security, including  export controls, complex export and sanctions enforcement matters, audits, CFIUS, cross-border due diligence, trade remedies (Sections 301, 201 and 232) and investigations (both classified and unclassified). For over 18 years, she is a member of several US Government Federal committees at State and Commerce that advise the agencies on issues related to national security and intelligence matters.

Katelyn M. Hilferty helps clients navigate US export controls and customs laws, sanctioned country regulations, anti-money laundering regulations, and national security issues. She has experience with classification/jurisdiction analyses, license applications, compliance counseling, investigations, and voluntary disclosures under the International Traffic in Arms Regulations (ITAR), Export Administration Regulations (EAR), and Office of Foreign Assets Control (OFAC) regulations. Additionally, she has counseled clients on transactions before the Committee on Foreign Investment in the US (CFIUS).

For more information, please visit www.morganlewis.com.