New Guidance Points to Potentially Aggressive Application of Secondary Sanctions on Russia

Peter Jeydel, Brian Egan, Ed Krauland, and Meredith Rathbone
January 11, 2018
Steptoe International Compliance Blog  

In recent weeks, the US Departments of State (State) and the Treasury (Treasury) have issued implementation guidance on the new secondary sanctions on Russia in the Countering America’s Adversaries Through Sanctions Act (CAATSA), which became law on August 2, 2017.  See our previous advisory for a general discussion of CAATSA.  This advisory addresses each of CAATSA’s Russia secondary sanctions provisions covered by the State and Treasury guidance, highlighting the significant risks that non-US companies may face under CAATSA when operating in Russia or doing business with Russian individuals or entities. 

Given the hawkish position on Russia taken by key members of Congress of both political parties, one can anticipate that Congress likely will expect aggressive implementation of these sanctions. While it is difficult to predict how aggressively the CAATSA secondary sanctions regime will be implemented, thus far it appears that the Trump Administration intends to comply with the strong legal mandate of the statute.  Recently, the administration has demonstrated its willingness to impose sanctions on Russian officials and entities with ties to President Putin in other contexts.  For example, on December 20, 2017, Treasury sanctioned Ramzan Kadyrov, a Russian official with close, if at times strained, ties to President Putin, under another statute, the Magnitsky Act, alleging he was “responsible for extrajudicial killing, torture, or other gross violations of internationally recognized human rights committed against individuals seeking to expose illegal activity carried out by officials of the Government of the Russian Federation…”

Those seeking to steer clear of these new secondary sanctions should consider and interpret all of the CAATSA provisions together.  Many of the provisions overlap, and limitations in the scope of one provision may not account for the breadth of other provisions.  The State Department is responsible for implementing some of the sanctions, while the Department of the Treasury’s Office of Foreign Assets Control (OFAC) is responsible for implementing others.  These agencies have made clear that they may interpret the same terms from CAATSA differently, depending on the context of the specific statutory provision.  Furthermore, OFAC has stated it intends to issue formal regulations for the CAATSA sanctions it will administer.

Sections 225 and 226: Special Russian crude oil projects

CAATSA Section 225 requires sanctions on non-US companies (as well as potentially their principal executive officers) that knowingly make a “significant investment” on or after September 1, 2017 in a “special Russian crude oil project,” which means deepwater (more than 500 feet deep in Russia’s exclusive economic zone), Arctic offshore, or shale projects in Russia.  Section 226 requires restrictions on US correspondent and payable-through accounts (which could include terminating or suspending such accounts) for foreign financial institutions (FFIs) that “knowingly” engage in “significant transactions” involving investments for which sanctions have been imposed under Section 225.  The State Department has been delegated the authority to impose sanctions under Section 225, and Treasury has been delegated the authority to impose sanctions under Section 226.   

Interplay between primary and secondary sanctions: The State Department’s guidance on Section 225 states “an investment is not significant if US persons would not require specific licenses from [OFAC] to make or participate in it.”  But the meaning of this guidance is not clear.  There are no general prohibitions or licensing requirements for US persons on making equity investments per se in Russian oil projects, provided that a Specially Designated National (SDN) is not involved.  Therefore, this presumably refers to the broad prohibition set forth in OFAC’s Directive 4 on US persons’ supplying any goods, non-financial services, or technology in support of any deepwater, Arctic offshore, or shale project in Russia, and possibly the Directive 2 restrictions on dealing in “new debt” relating to certain Russian energy companies.  If so, it is not clear how this will be interpreted and administered.

Meaning of “investment”: Neither the State nor the OFAC guidance defines the term “investment” for purposes of Sections 225 and 226.  State’s guidance on Section 225 explains that an investment “could include arrangements where goods or services are provided in exchange for equity in an enterprise or rights to a share of the revenue or profits of an enterprise.”  Based on State’s guidance, suppliers to special Russian crude oil projects would be at risk if they were to agree to compensation terms that could be considered “rights to a share of the revenue or profits of an enterprise.”

State’s guidance does not indicate whether “investments” under Section 225 extend to circumstances involving debt (where, for example, rights to “revenue or profits of an enterprise” may result from default on a debt, or potentially even where the debt instrument itself could be viewed as providing rights to revenue or profits).  However, State’s guidance above (that “an investment is not significant if US persons would not require specific licenses from [OFAC] to make or participate in it”) suggests that debt financing may be a target of these sanctions, as debt is a major focus of OFAC’s specific licensing regime.  Moreover, OFAC’s Frequently Asked Questions (FAQs) indicate that the term “investment” will extend to circumstances involving debt under another provision of CAATSA – Section 233.  Until there is more clarity on whether State will take a similar approach to investments under Section 225, it would be prudent for non-US investors and suppliers in Russia’s oil sector to monitor their invoicing to ensure they are paid within the stated debt maturity periods of OFAC’s Directives applicable to US persons, and otherwise avoid any restricted debt of sanctioned Russian companies, or the oil projects in which they are involved.   

Case-by-case assessment of which investments or transactions are “significant”: State and OFAC have maintained discretion in determining whether investments are “significant” under Sections 225 and 226.  State’s guidance on Section 225 explains that, “in determining whether an investment is significant,” State “will consider the totality of the facts and circumstances surrounding the investment and weigh various factors on a case-by-case basis,” including “the significance of the transaction to US national security and foreign policy interests, in particular where the transaction has a significant adverse impact on such interest; the nature and magnitude of the investment, including the size of the investment relative to the project’s overall capitalization; and the relation and significance of the investment to the Russian energy sector.”  In its FAQs on Section 226, OFAC indicates that it will consider “seven broad factors” in analyzing whether a FFI 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.”

Section 228: Russia sanctions “violations” by non-US persons

Perhaps the broadest provision in CAATSA is Section 228, which requires the president to impose sanctions on any “foreign person” that “knowingly,” on or after August 2, 2017, “materially violates, attempts to violate, conspires to violate, or causes a violation of” any US sanctions on Russia. 

Meaning of “material” violation: OFAC, which is responsible for implementing Section 228, has clarified in its FAQs on Section 228 that it will interpret the term “materially” violate to refer to an “egregious” violation under OFAC’s Economic Sanctions Enforcement Guidelines.  The Guidelines state that, in making the egregiousness determination, OFAC generally will put “particular emphasis” on whether the violation was “willful or reckless” and whether there was “awareness” of the conduct, including the following factors: concealment, pattern of conduct, prior notice that it was a violation of US law, and management involvement.  The Guidelines also indicate that OFAC will “give substantial weight” to any “harm to sanctions program objectives” (e.g., any benefit for the sanctions target and implications for US policy objectives, among others) and other characteristics (such as the company’s commercial sophistication, size/transaction volume, financial condition, and sanctions history).  For example, a single, small transaction by a less sophisticated company is less likely to be sanctionable under Section 228, but more significant transactions may trigger this provision.

Scope and effect:  Because OFAC has not defined “violation” for purposes of Section 228, it is possible that Section 228 sanctions could be triggered by any activity by non-US persons that would be considered a violation of OFAC’s Russia sanctions by a US person.  This interpretation would essentially extend to non-US persons the entire US primary sanctions program on Russia, to the extent the conduct is deemed to be “egregious.”  Without detailing every applicable rule, this includes the new debt and new equity restrictions in OFAC’s Directives 1-3, the oil project supply restrictions in OFAC’s Directive 4, the comprehensive trade and investment embargo on the Crimea region, and the prohibition on any transactions or dealings with SDNs designated under OFAC’s Russia authorities.  As an illustration, any dealings in new debt of greater than 14 days maturity or new equity of most Russian banks would be sanctionable if determined to be “egregious” based on the factors above.  The same is true with respect to any transaction involving a Russian SDN.  Non-US companies with significant business in Russia are now faced with considering the same compliance expectations that apply to US companies, and should not underestimate the potential breadth of this authority.  While CAATSA does not apply civil and criminal penalties for engaging in sanctionable conduct, as OFAC’s rules do when US persons are involved, the “secondary sanctions” measures that CAATSA does impose can have the effect of cutting a non-US person off from the US commercial market and the international financial system.  Non-US companies with significant business in Russia are now faced with considering the same compliance expectations that apply to US companies.  Given the potential breadth of this statutory authority, this is an area of the law where clarification should be sought especially in light of the potential implications for non-US companies. 

Section 228: Facilitating transactions for Russian SDNs or SSI entities

Section 228 also requires the imposition of sanctions on a “foreign person” that “knowingly,” on or after August 2, 2017, “facilitates a significant transaction, including deceptive or structured transactions, for or on behalf of” any person subject to US Russia sanctions, or their immediate family members.  OFAC clarified in its FAQs on Section 228 that the sanctioned persons covered by this provision include both SDNs and entities subject to OFAC’s Directives on the Sectoral Sanctions Identifications (SSI) list, and any entity owned 50% or more by SDNs or SSI entities.  This portion of Section 228 is yet another way in which CAATSA leverages the US primary sanctions program to target activity by non-US persons with no jurisdictional link to the United States. 

More than just financial services: OFAC explained in these FAQs that “facilitate” means “providing assistance for a transaction from which the person in question derives a particular benefit of any kind,” including financial services, brokering, transportation, “the provision of other services of any kind; the provision of personnel; or the provision of software, technology, or goods of any kind.”  This section therefore implicates a broad array of sectors, and all companies doing business in Russia or involving individuals or entities potentially linked to Russia, should now be conducting due diligence and screening for sanctioned parties to avoid falling afoul of this provision.   

Meaning of “significant:” OFAC’s FAQs state that “a transaction is not significant if US persons would not require specific licenses from OFAC to participate in it.”  For SDNs, that is not a meaningful limitation, because US persons generally require a specific license from OFAC to conduct any transaction or dealing with SDNs.  But for SSI entities, that is a meaningful limitation, by referring back to the applicable Directives.  The FAQs go on to state that, for SSI entities, the transaction “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 US person would require a specific license from OFAC to participate in it and it involves deceptive practices.  In all cases, the totality of the circumstances…will shape the final determination of significance,” based on the same seven factors as listed above for Section 226.  The FAQs narrow the scope of Section 228 for transactions involving SSI entities – with an emphasis on transparency as well as the seven “significance” factors – but set out a very broad sanctions authority whenever SDNs are involved.

Section 226: Facilitating financial transactions for Russian SDNs

Overlapping with Section 228, Section 226 requires restrictions on the correspondent or payable-through accounts of an FFI that, on or after September 1, 2017, “knowingly facilitated a significant financial transaction on behalf of any Russian” SDN designated under OFAC’s Russia authorities.  OFAC has indicated it will interpret broadly the terms “facilitated” and “financial transaction” under Section 226.  Therefore, the key question for FFIs, in addition to conducting due diligence to screen for the possible involvement of Russian SDNs, is whether OFAC may consider a transaction or series of transactions to be “significant,” based on the same seven factors above.

Section 233: Transactions with Russia’s state-owned sector

Section 233 requires sanctions on “a person” that, “with actual knowledge,” on or after August 2, 2017, “makes an investment of $10,000,000 or more (or any combination of investments of not less than $1,000,000 each, which in the aggregate equals or exceeds $10,000,000 in any 12-month period), or facilitates such an investment, if the investment directly and significantly contributes to the ability of the Russian Federation to privatize state-owned assets in a manner that unjustly benefits – (1) officials of the Government of the Russian Federation; or (2) close associates or family members of those officials.” 

A key narrowing factor in Section 233 is the “actual knowledge” standard.  This differs from most other secondary sanctions authorities, which use the term “knowingly” and include situations when the actor has “reason to know” that sanctions may apply.  Actual knowledge, while not defined in CAATSA, does not imply the same type of due diligence expectation, but may well still encompass deliberate “head in the sand” situations or purposeful avoidance of facts.

Otherwise, the scope of Section 233 may be quite broad.  For example, OFAC’s FAQs on Section 233 state that it “will interpret the term ‘investment’ broadly” under Section 233 to include any “transaction that constitutes a commitment or contribution of funds or other assets or a loan or other extension of credit to an enterprise…”  This expansive interpretation appears to encompass not only traditional equity investments, but also bank loans or other debt financing, providing other assets, or potentially just about any transaction involving Russia’s state-owned sector.  The term “privatize” is not defined, although it presumably would limit in some way the scope of a sanctionable “investment.”  Without further guidance on this issue, one is left to consider the variety of ways in which transactions involving state-owned assets could contribute to their eventual privatization.  OFAC’s FAQs make clear that it will broadly construe the terms “facilitate” (which includes, for example, the provision of currency or other financial instruments, goods, services, software, technology, or personnel) and “unjustly benefit” (which can include any “direct or indirect,” “tangible or intangible” benefit that the US government may view as inappropriate – it does not appear to be limited to benefits stemming from “public corruption”). 

What this means is that any transaction or series of transactions of $10 million or more involving state-owned assets in Russia could potentially be subject to secondary sanctions risk if there is any overt indication that a Russian official, or an associate or family member – very broadly defined – of a Russian official, could obtain any “advantage,” even “intangible,” even “indirectly,” from the transaction, and that the transaction could “directly and significantly” contribute to Russia’s ability to privatize state-owned assets. 

Section 227: Facilitating corruption in Russia

Complementing Section 233, Section 227 requires sanctions on “any individual who has materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services in support of,” “significant corruption” involving Russian officials or their associates or family members anywhere in the world.  Notably for banks, attorneys, and other service providers, this includes the “facilitation or transfer of the proceeds of corruption to foreign jurisdictions.”

Neither OFAC (which is in charge of implementing this provision) nor State (which is responsible for issuing waivers) has issued any guidance on this provision.  On its face, this is a broad new mandatory sanction, with worldwide application and no “knowledge” requirement.  While presumably the US government will exercise reasonable discretion in not applying sanctions for inadvertent conduct, this does call for due diligence when conducting dealings that may be related to Russia or Russian officials anywhere in the world to determine whether there may be an underlying element of “significant corruption.” 

Section 231: Transactions with Russia’s Defense and Intelligence Sectors

See our previous advisory specific to Section 231 for a detailed discussion of this important provision.  Since the date of that advisory, State Department officials have indicated (though not in formal, published guidance) that these sanctions will not generally apply to non-listed affiliates of the entities that are named on the State Department’s list of entities that are part of, or operate for or on behalf of, the Russian defense or intelligence sectors.  However, it is important to exercise due diligence nonetheless (for example, if a non-listed affiliate is not a bona fide operating entity in its own right, distinct from the listed company, or if the non-listed affiliate is acting as an agent of the listed company).

Section 232: Transactions related to Russian energy export pipelines

Section 232 authorizes, but does not require, sanctions on “a person” that “knowingly” engages in either of the following types of activity, with “a fair market value of $1,000,000 or more” or, during a 12-month period, “an aggregate fair market value of $5,000,000 or more:” (1) makes an “investment that directly and significantly contributes to the enhancement” of Russia’s ability to construct “energy export pipelines;” or (2) sells, leases, or provides to Russia, for the construction of “Russian energy export pipelines,” goods, services, technology, information, or support “that could directly and significantly facilitate the maintenance or expansion of the construction, modernization, or repair of energy export pipelines” by Russia. 

In its guidance on Section 232, the State Department, which is responsible for implementing Section 232, reiterates that these sanctions are not mandatory, that the US government will coordinate with allies in this area, and that “any implementation of Section 232 sanctions would seek to avoid harming the energy security of our partners or endangering public health and safety.”

The State Department’s guidance also states that “the focus of implementation would be on energy export pipelines that (1) originate in the Russian Federation, and (2) transport hydrocarbons across an international land or maritime border for delivery to another country.  Pipelines that originate outside the Russian Federation and transit through the territory of the Russian Federation would not be the focus of implementation.”  The guidance also states that the focus of implementation would be on covered activity involving pipeline projects initiated on or after August 2, 2017, which refers to the point when “a contract for the project is signed.  Investments and loan agreements made prior to August 2, 2017 would not be subject to Section 232 sanctions.”  State explains that Section 232 will not “target investments or other activities related to the standard repair and maintenance of pipelines in existence on, and capable of transporting commercial quantities of hydrocarbons,‎ as of August 2, 2017.”

Primary sanctions changes: Modification of OFAC Directives and authority to designate new sectors

Section 223 of CATSA made a number of important changes to the US primary sanctions program on Russia.  See our previous discussions of the changes required by CAATSA to OFAC’s restrictions on US person dealings in new equity and new debt of sanctioned Russian financial institutions and energy companies, and the restrictions on US persons’ supplying certain oil projects in Russia, or outside Russia with Russian ownership.

Section 223 also authorized, but did not require, the extension of US primary sanctions to the railway or metals and mining sectors in Russia.  OFAC’s guidance indicates that it has not decided to extend sanctions to these sectors at this time, and confirms that “maintaining unity with partners” of the United States will be important in considering any further extension of these sanctions.

Other provisions

OFAC and State have not yet provided any guidance on the following provisions, which we discussed in our prior advisory:

  • Section 228 (other aspects of which are discussed above), which also provides for sanctions for activity involving persons suspected of human rights abuses in the Crimea, Eastern Ukraine, or other regions under disputed Russian control in Georgia, Moldova and elsewhere, along with potentially in Russia itself. 
  • Section 224, which provides for sanctions for activity related to cyber attacks on behalf of the Russian government.
  • Section 234, which provides for sanctions for defense sector activity related to Syria.

In the coming months, CAATSA also requires the administration to submit a number of Russia-related reports to Congress:

  • Section 241 requires a detailed report to Congress, by January 29, 2018, on Russian senior foreign political figures, “oligarchs,” and “parastatal entities,” including the potential impacts of imposing additional sanctions with respect to these persons and entities.  This provision has been receiving attention in the press as some interpret the report as the prelude to further sanctions directed at identified individuals.
  • Section 242 requires a detailed report to Congress, by January 29, 2018, on the potential effects of restricting US persons from dealing in Russian sovereign debt and derivative products.  See our recent discussion of the impact of this provision and others on the Russian sovereign debt market.
  • Section 243 requires an annual report every August, beginning in 2018, describing the US government’s efforts “to combat illicit finance relating to the Russian Federation,” including through identification of “foreign sanctions evaders and loopholes within the sanctions regimes of foreign partners of the United States.”

While these reports do not necessarily need to be made public by the administration or by Congress, they could lead to a further expansion of sanctions or other consequences. 

Conclusion  

The guidance that State and OFAC have issued suggests that they intend to implement CAATSA, as required by the statute.  This calls for caution by those engaged in commerce or financial transactions involving Russia.  We expect continued pressure from Congress in 2018 to ensure aggressive implementation of these statutory mandates.

We will continue to keep you informed of sanctions developments in Russia and elsewhere. If you have any questions, please contact Edward Krauland at +1 202 429 8083, Brian Egan at +1 202 429 8009, or Peter Jeydel at +1 202 429 6291 in our Washington office, or Meredith Rathbone at +44 20 7367 8021 in our London office.  Further commentary is available on the Steptoe International Compliance Blog.  You can also follow us on Twitter (@SteptoeIntlReg).