Are Your Third Parties Violating Sanctions Against Iran, Syria?

Despite a potential thaw in the icy relationship between the United States and Iran, regulators are coming down harder than ever on companies that do business with rogue states, including those whose only connection to countries like Iran and Syria is through third parties.

The Securities and Exchange Commission is also playing a bigger role in the crackdown. Since 2003, potential sanctions violations involving SEC-registered companies have been reviewed by its Office of Global Securities Risk, with a specific mandate to focus on assuring that company dealings with countries the United States identifies as state sponsors of terrorism (Iran, Sudan, Syria, North Korea, and Cuba) are properly reflected and disclosed in company filings.

Last year Congress raised the stakes when it passed the Iran Threat Reduction and Syria Human Rights Act, which requires issuers to disclose, in an annual or quarterly report, if they or any affiliate has “knowingly” conducted transactions with the Iranian or Syrian government and its various entities. A new EDGAR form, called IRANNOTICE, was created to satisfy new reporting requirements.

Among the activities requiring disclosure are knowingly transferring any goods, services, or technologies that could contribute to Iran's ability to acquire or develop weapons of mass destruction. Also prohibited, and requiring disclosure, is providing materials, technology, or services that benefit Iranian production of petroleum and related products or can be tied to human rights abuses. Transactions involving the government of Iran, and Iranian parties that are “Specially Designated” as blacklisted parties under U.S. sanctions on Iran, also are subject to disclosure.

Samuel Wolff, a partner with the law firm Akin Gump who specializes in securities law, points to recent SEC staff comment letters for insight into its expanded role in pursuing violations of country sanctions. One recent exchange required an undisclosed company to evaluate whether a transaction involving the National Iranian Oil Company should have been disclosed. A vessel owned by the company and chartered to a third party loaded crude oil in Iran that was shipped to China.

The undisclosed company admitted that the oil was loaded in Iran, but argued that since the ship was chartered to a third party and controlled by it, the company in question did not have to make the disclosures. The SEC pushed back and the issuer, without admitting prior knowledge, agreed to amend their annual report.

Wolff explains what is interesting about the recent comment letters he reviewed. In one of them SEC staff says it was alerted to the transaction from a news article. “That tells us they monitor outside sources,” he says.

The letters also provide insight into the SEC's active approach to the fairly new reporting requirements. By these disclosures, the SEC's efforts put offending companies squarely in the spotlight of the key U.S. sanctions enforcement agencies, including the Treasury Department's Office of Foreign Asset Control and the State Department. It is “another jurisdictional hook,” Wolff says. When a company files a 13(r) disclosure, the SEC is required to report that filing to these agencies and the White House.

“The implications of filing a disclosure like this are substantial in terms of the potential legal exposure a company could encounter if it is not in compliance with applicable U.S. sanctions laws,” says Wynn Segall, a partner at Akin Gump who focuses on export controls and economic sanctions.

There is also the potential of having to conduct an investigation, even if the company has not violated U.S. sanctions laws. "In one of the letters, the SEC staff said  that, by providing its comments, it is not saying that it won't bring an enforcement action,” Wolff says Reputational risk, in the United States and European Union, is also a concern.

“Most U.S. publicly traded companies saw the writing on the wall with respect to Iran. Five years ago we saw companies pulling out and winding down their activities.”

—Meredith Rathbone,

Partner,

Steptoe and Johnson

The rationale for the SEC's activity, prodded as it may be by other agencies, is that investors—especially large pension funds and institutional investors—consider these dealings with countries on the U.S. sanctions list to be material.

“We've seen a very large number of 13(r) filings included in quarterly and annual filings since this went into effect in February,” Segall says. Many more—particularly those with vast holdings or several affiliates around the world—are working hard to determine if they need to file the disclosures, he says.

“This is the first instance we are aware of where the Office of Global Securities Risk appears to be involved in issuing a comment letter specifically questioning whether a registrant has complied with a disclosure requirement like this,” he says. This approach differs from dialogues it has had with other companies in the past, which focused on more traditional questions on issuer judgments of materiality, not an expressed disclosure obligation,” he says.

Some Trade With Iran

Aggressive enforcement and new disclosure demands should come as no surprise, says Meredith Rathbone, a partner in law firm Steptoe and Johnson, who focuses on international regulatory compliance. “Most U.S. publicly traded companies saw the writing on the wall with respect to Iran,” she says. “Five years ago we saw companies pulling out and winding down their activities.”

Not all companies, however, are prohibited from doing business there. Exemptions allow trade for pharmaceuticals, medical devices, and food exports. Nevertheless, they should exercise caution as “in the course of conducting their due diligence they may find out that they have some foreign affiliate who still engages in some prohibited business that they weren't aware of.”

And the U.S. government is casting the net even wider. “U.S. sanctions related to Iran used to be focused primarily on U.S. companies and their activities,” Rathbone says. Now they are expanded “to rope in their foreign affiliates and foreign subsidiaries.”

EDGAR FILING REQUIREMENTS

The following was issued by the Securities and Exchange Commission to notify issuers of disclosure obligations under the Iran Threat Reduction and Syria Human Rights Act of 2012. The EDGAR filing requirements began earlier this year.

Section 219 of the Act amends Section 13 of the Exchange Act to add new subsection (r), which requires an issuer that files Exchange Act periodic reports to provide disclosure in its periodic report if during the reporting period it or any of its affiliates has knowingly engaged in certain specified activities involving contacts with or support for Iran or other identified persons involved in terrorism or the creation of weapons of mass destruction.

Section 13(r) also requires an issuer that includes a description of an identified activity in a periodic report to concurrently file with the Commission a notice that identifies the issuer and indicates that disclosure of the activity has been included in its periodic report.

Issuers required to file the notice should prepare a separate document that includes the information required by the statute, convert it to ASCII or HTML as instructed by the EDGAR Filer Manual, and submit it using a new EDGAR form type called IRANNOTICE. EDGAR will receive and disseminate these notices in the same way it does the concurrently filed annual or quarterly reports. The notices will appear with the issuer's filing history on EDGAR and will be searchable through that system.

Source: SEC.

Just how aggressively the SEC will pursue affiliates overseas remains to be seen. “I don't think it will result in a lot of enforcement, because those extraterritorial sanctions and statutes are not generally enforced against large, publicly traded companies,” she says. Instead, it will primarily expose non-U.S. companies and require them to go public with their Iran-related activities providing a “window into what they are they doing.” “They may be hearing from the State Department,” she says. “In fact, I would be surprised if they didn't.”

The new disclosure rules could also work in reverse, dragging in parent companies of U.S.-based subsidiaries. “The SEC requirements are really quite broad and don't just apply to controlled affiliates,” Rathbone says. “They also apply to the parent companies. There is a situation where you may have a U.S. company that is listed on an exchange that has to report about the activities of their parent company. It is difficult and many companies really don't want to be in the SEC's spotlight for Iran-related activity generally, but certainly not for activity that is sanctionable.”

States are also getting into the act. Over the years, there have been legislative efforts to bar state pension funds from investing in companies that engage in activity in Iran. In Florida, legislators attempted to cut into the trade of companies that do business in Cuba, passing a law that barred anyone doing business there, humanitarian efforts included, from contracting with the state government. It was removed from the books after a legal challenge argued the state's sanction law could not supersede federal ones that included carve-outs for food and medicine.

The New York Department of Financial Services has also pursued violations of sanctions. In the past 12 months, it has entered into a $340 million settlement with Standard Chartered Bank, a $10 million one with Deloitte Financial Advisory Services, and a $250 million settlement with Bank of Tokyo Mitsubishi-UFJ for failing to comply with Iran sanctions. This summer, the agency turned its focus to the Iran Freedom and Counter-Proliferation Act, asking 20 non-U.S. reinsurers to document their compliance efforts amid suspicions that some may have issued insurance coverage to trades made with Iran.

Rathbone sees it as a logical fit for New York to take on such a task, but it might not fly elsewhere. “Financial transactions and insurance are heavily linked to economic sanctions, and New York, of course, is the center of the financial industry,” she says. “New York can do this and what are the banks going to do? Start moving out? “Whether or not more states will start to do this, I'm not sure,” she adds. “We'll see if someone starts a trend and others pick up on it.”