Checking the Scorecard - Revising the Model Forms: Hot Points Driving Change Thursday, April 29, :15 p.m. 4:15 p.m.

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1 2010 ANNUAL SPRING INVESTMENT FORUM American College of Investment Counsel Chicago, IL Checking the Scorecard - Revising the Model Forms: Hot Points Driving Change Thursday, April 29, :15 p.m. 4:15 p.m. Clint L. Woods AEGON USA Investment Management, LLC (Moderator) Dewey B. Crawford Foley & Lardner LLP Scott Alan Falk Bingham McCutchen LLP Simeon M. Kriesberg Lenny Mazlish CIGNA Corporation

2 LENDERS LIVING ON BORROWED TIME: INTERNATIONAL TRADE COMPLIANCE DEFECTS IN MODEL LOAN AGREEMENTS 1 By Simeon M. Kriesberg K Street, N.W. Washington, D.C Main Tel Main Fax Simeon M. Kriesberg Direct Tel Direct Fax skriesberg@mayerbrown.com Lending transactions almost always require compliance with various U.S. international trade laws, even if neither the lender nor the borrower is organized under U.S. law or based in the United States. This paper focuses on four such international trade laws that warrant the attention of lenders: (i) the U.S. Foreign Corrupt Practices Act, (ii) the U.S. export control laws, (iii) the USA PATRIOT Act, and (iv) the U.S. embargoes or economic sanctions laws. Although the application of these laws to specific lending transactions depends heavily on the particular factual circumstances, even the overview presented here can highlight the substantial risks that lenders face if they are not careful to determine the applicability of these laws and to implement This article was prepared for the 2010 Spring Forum of the American College of Investment Counsel. An earlier version of this article was published at 123 Banking Law Journal 579 (2006) and presented at the 2006 Spring Forum of the American College of Investment Counsel. 2 Simeon M. Kriesberg is a partner in the international law firm of, 1999 K Street, NW, Washington, D.C He has advised leading global financial institutions and other clients on international trade compliance for over 30 years. He may be reached at skriesberg@mayerbrown.com, or at 202/ (tel), 202/ (fax). For more information, visit The description of international trade laws presented here is as of March 31, operates in combination with our associated English limited liability partnership and Hong Kong partnership (and its associated entities in Asia) and is associated with Tauil & Chequer Advogados, a Brazilian law partnership.

3 effective compliance measures. Unfortunately, commonly used representations, warranties, and covenants in model loan agreements may offer a false sense of comfort and may not achieve the intended assurance of compliance. Following a summary of the four international trade laws, the paper critiques certain standard provisions in loan agreements that raise issues for international trade compliance. 3 I. The U.S. Foreign Corrupt Practices Act The combination of wide-ranging application and aggressive enforcement make the U.S. Foreign Corrupt Practices Act ( FCPA ) a law to be reckoned with in lending transactions. The FCPA includes both accounting and antibribery provisions. A. The Accounting Provisions The accounting provisions of the FCPA apply to issuers of securities registered with the Securities and Exchange Commission; officers, directors, employees, and agents of such issuers; and stockholders acting on behalf of such issuers. The accounting provisions require that an issuer maintain books, records, and accounts that accurately and fairly reflect the transactions and dispositions of the assets of the issuer. The accounting provisions also require that an issuer maintain a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements and to maintain accountability for assets, (iii) access to 3 The model agreement used for this article s target practice is the Final Updated Model Form #2 Note Purchase Agreement, September 15, 2004 (corrected April 15, 2006) promulgated by the American College of Investment Counsel. Many other form agreements have defects similar to those identified in this particular model form. 2

4 assets is permitted only in accordance with management authorizations, and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. B. The Antibribery Provisions The antibribery provisions of the FCPA apply to the persons subject to the accounting provisions as well as to the following persons: individuals who are citizens, nationals, or residents of the United States; corporations, partnerships, associations, joint-stock companies, business trusts, unincorporated organizations, and sole proprietorships, insofar as such entities have their principal place of business in the United States or are organized under the laws of any State, territory, possession, or commonwealth of the United States; officers, directors, employees, and agents of the foregoing entities; and stockholders acting on behalf of the foregoing entities. Also covered are foreign persons that commit in the United States an act in furtherance of a foreign corrupt practice, as defined below. The antibribery provisions of the FCPA prohibit any subject person from offering or giving anything of value to a foreign government official, a foreign political party or party official, a foreign political candidate, or an official of a public international organization for purposes of (i) influencing any act or decision of such recipient in an official capacity, (ii) inducing the recipient to do or omit to do an act in violation of the lawful duty of such recipient, or (iii) securing any improper advantage, all in order to obtain, retain, or direct business for or to any person. The antibribery provisions also prohibit any such person from offering or giving anything of value to any other person if the giver knows that all or a portion of the gift will be offered or given, directly or indirectly, to a foreign government official, a foreign political party 3

5 or party official, a foreign political candidate, or an official of a public international organization for the foregoing purposes. In the context of this latter prohibition, the requisite knowledge exists if the giver is aware or has the firm belief that the prohibited conduct is substantially certain to occur; conscious disregard or deliberate ignorance of pertinent circumstances are not excused. The antibribery provisions include one exception and two affirmative defenses. Pursuant to the exception, the antibribery provisions do not apply to any facilitating or expediting payment the purpose of which is to expedite or secure the performance of routine governmental action by a foreign government official, a foreign political party, a foreign political party official, or an official of a public international organization. Routine governmental action may include (i) obtaining permits or licenses, (ii) processing governmental papers, (iii) scheduling inspections, (iv) providing police protection, postal services, and telephone service, (v) supplying power and water, (vi) loading and unloading cargo, (vii) protecting perishable products from deterioration, and (viii) other similar actions ordinarily and commonly performed by foreign officials. If the governmental action in question requires an official s discretion or judgment, or is not an action to which the party making a facilitating payment is legally entitled, then the action is not routine governmental action for purposes of the FCPA. For example, routine governmental action does not include decisions to award or continue business nor actions affecting such decisionmaking. Pursuant to the affirmative defenses, a person may defend against prosecution for violations of the FCPA s antibribery provisions on the grounds that (i) the offering or giving of something of value was lawful under the written laws and regulations of the country of the official, party, or candidate involved, or (ii) the offering or giving of something of value was a reasonable and bona fide expenditure (such as travel or lodging expenses) incurred by or on 4

6 behalf of the official, party, or candidate involved and was directly related to the promotion, demonstration, or explanation of products or services or to the execution or performance of a foreign government contract. As the foregoing summary suggests, the application of the FCPA to particular transactions or circumstances depends heavily on the specific facts. It is advisable to consult with knowledgeable counsel with respect to the application of the FCPA to particular transactions or circumstances. Consultation is especially advisable in determining whether the statutory exception or the affirmative defenses might apply. C. Penalties for Violations Violators of the FCPA may incur civil or criminal penalties, depending on the circumstances. Individuals may face civil fines of the greater of $100,000 or the gross gain from each violation; for entities, the civil fines may be up to the greater of $500,000 or the gross gain. Individuals may face criminal fines of up to the greater of $250,000 to $2 million or twice the gross gain, while corporations may be fined criminally up to the greater of $2 million to $25 million or twice the gross gain. Criminal sentences of up to 5-20 years in prison may be imposed on individuals. Any fines imposed upon officers, directors, stockholders, employees, or agents of a corporation must be paid by the individuals without reimbursement by the corporation. In addition to these penalties, corporate or individual violators of the FCPA may be subject to additional fines or prison sentences under other federal criminal statutes, such as the Racketeer Influenced and Corrupt Organizations ( RICO ) Act. Moreover, corporate violators may be barred from contracts with the United States Government, may be required to disgorge unlawfully obtained profits, and may be denied export licenses. 5

7 The United States Government takes the FCPA quite seriously and is not hesitant to prosecute violators. Until the last few years, fines in the tens of millions of dollars were unusual, but the intensity of enforcement activity and the size of monetary penalties has increased notably recently. In 2008, for example, Siemens and certain of its affiliates were penalized some $800 million for violations of the accounting provisions; in 2009 former Halliburton affiliate KBR was penalized over $550 million for various FCPA violations; in 2010 BAE Systems settled FCPA charges for a fine of some $400 million. Among the key features of the current enforcement environment are enforcement actions that involve coordination among authorities in several national jurisdictions, actions that range across a company s global operations, prosecutions of multiple members of the same industry, actions against individuals, and new emphasis on violations arising from promotional expenditures and on violations uncovered in the context of acquisitions and joint ventures. Having an effective FCPA compliance program in place is crucial preventive medicine. Furthermore, in the event that a violation does occur, the existence of an effective FCPA compliance program may mitigate the sanctions that are otherwise applicable. The Securities and Exchange Commission and the Department of Justice, which enforce the FCPA, as well as the U.S. Sentencing Commission, which promulgates sentencing guidelines for the federal courts, have all emphasized the relevance of compliance programs in determining the severity of the sanctions that are imposed for violations of law. II. The U.S. Export Control Laws Broadly, U.S. export controls are restrictions on the exportation from the United States, by U.S. or non-u.s. persons, of products, software, and technology, and the re-exportation from 6

8 foreign countries of U.S.-origin products, software, and technology. Although several U.S. government agencies administer export controls, the Department of Commerce has the broadest jurisdiction and is the most relevant to non-military export activities. So-called dual-use controls controls applicable to items that are of both commercial and military use are set forth in the Export Administration Regulations ( EAR ), and are administered by the Bureau of Industry and Security ( BIS ) of the Department of Commerce. The EAR and other useful compliance information can be found at the BIS website: 4 The EAR impose varying levels of controls on the exportation and re-exportation of products, software, and technology based on: (i) the technical sophistication and potential use of the item to be exported; (ii) the country of destination; (iv) the proposed end-use of the item; and (v) the particular end-user that will receive the item. Generally, all products, software, and technology exported from the United States, or made in the United States and exported from abroad, are subject to the requirements of the EAR. The EAR also apply to some foreign-made items if they contain certain proportions of U.S.-origin content or if their manufacture uses U.S.- origin technology. The rationale for export controls is the furtherance of U.S. foreign policy objectives, including national security, limitation of the proliferation of nuclear weapons and weapons of mass destruction, elimination of terrorism, and so forth. Any item that is sent from 4 Export controls on articles and services that are primarily for military use are set forth in the International Traffic in Arms Regulations ( ITAR ), and are administered by the Directorate of Defense Trade Controls of the Department of State. Lenders to companies that export U.S.- origin military and other defense items should become familiar with the ITAR. The antiboycott regulations, which are part of the EAR, govern the action of U.S. persons with respect to unsanctioned international boycotts and bar participation by U.S. persons in the Arab League boycott of Israel. Lenders that engage in transactions in the Middle East must pay particular attention to these complex regulations. The ITAR and the antiboycott regulations are beyond the scope of this article. 7

9 the United States to a foreign destination is considered to be exported. Exportation includes not only shipping merchandise abroad but also such alternative means as carrying product samples outside the United States, bringing software to a foreign country on a laptop computer, and transferring technology to a wholly-owned U.S. subsidiary in a foreign country. As discussed in greater detail below, exportation also includes affording to foreign nationals in the United States access to U.S.-origin technology or source code. A. Exports of Products, Software, and Technology from the United States With the exception of most exports to Canada, exportation from the United States of any product, software, or technology (collectively, items ) must be authorized either (i) by a BISissued license or classification ruling, or (ii) by the exporter s own determination that the exportation is permissible under a license exception set forth in the EAR or that the exportation is permissible because no license is required. Licensing requirements also apply to the reexportation of items subject to the EAR, as discussed below. The first step in determining whether an export license is needed is to ascertain whether the item to be exported has a specific Export Control Classification Number (ECCN). All ECCNs are listed on the Commerce Control List (CCL), which is part of the EAR. Exporters are responsible for determining the correct ECCN for all the items that they export. An exporter may classify an item on its own, or the exporter may, for greater assurance, obtain a classification from BIS by submitting a classification request. BIS does not charge a fee for a classification ruling or for an export license. The ECCN entry on the CCL states the types of controls placed on that item, along with a country chart designator. These designators refer to the Commerce Country Chart contained in the EAR, which lists the types of export controls generally applicable to items destined for specified countries. By identifying the type of control 8

10 required by the ECCN classification and the country to which the particular item is to be exported, an exporter can ascertain whether a license is needed to export that particular item to that particular country. Certain items are subject to the jurisdiction of the EAR, but are not described on the CCL by a particular ECCN. These items are classified as EAR 99. Typically, items classified as EAR 99 do not require an export license based on national security or other policy concerns reflected in the Commerce Country Chart. Certain restrictions may apply, however, based on the country of destination, the end-use, and the end-user, as discussed below. Only a small percentage of all U.S. exports require a license from BIS based upon their classification. Even if a license is required for a particular transaction, a license exception may be available. For example, license exceptions may be available for low-value shipments and for temporary exports that remain under the exporter s control. The availability of a particular license exception may depend upon the country of destination and the item exported. License exceptions and the conditions for their use are set forth in the EAR. For certain destinations, all items, even those classified as EAR 99, require a license prior to exportation. These destinations are embargoed countries or countries designated as supporting terrorist activities, currently including Cuba, Iran, North Korea, Sudan, and Syria. BIS has overlapping jurisdiction with the Office of Foreign Assets Control of the Department of the Treasury ( OFAC ) with respect to embargoed countries. The OFAC-administered embargo programs are discussed in Part IV of this paper. The EAR also contain certain end-use restrictions. Some end-uses are prohibited while others may require a license. For example, without a license from BIS, an exporter may not 9

11 export items of any kind to entities involved in the proliferation of nuclear, biological, or chemical weapons and the missiles to deliver them. Finally, there may be restrictions on export transactions based upon the end-user of the items. Certain entities and individuals are prohibited from receiving U.S. exports and others may only receive items if the exportation has been licensed. These restricted end-users are identified by BIS and posted on its website, in such listings as the Denied Persons List, the Entity List, and the Unverified List. Exporters are responsible for ensuring that their exports are not destined for such end-users. B. Re-Exports of U.S.-Origin Products, Software, and Technology Of particular importance to international lending transactions is the application of U.S. export controls to re-export transactions occurring outside the territory of the United States. The EAR apply to U.S.-origin items, wherever located, and place restrictions on foreign persons reexporting to a third country items that were originally exported from the United States. If the items are of U.S.-origin, or in some cases based on U.S.-origin technology, or contain a certain percentage of U.S.-origin content, then the exporter in the foreign country may have to obtain a U.S. export license before it may re-export the items. Generally, a license is not required for items that at the time of re-exportation could be exported directly from the United States to the new destination without a license. C. Re-Exports of Foreign-Produced Products Incorporating U.S. Content The EAR also place restrictions on the re-exportation of certain foreign-produced products incorporating U.S.-origin parts, components, or software, or foreign-produced products based on U.S. technology. The EAR exempt from control, however, those foreign-made items 10

12 with de minimis U.S. content. For products destined for embargoed countries, de minimis U.S. content is 10 percent of the total product value. For products destined for non-embargoed destinations, de minimis U.S. content is defined as 25 percent of the total value. The EAR contain detailed rules regarding the calculation of the value of U.S.-content. There are limitations on the de minimis exception for foreign-made products that incorporate U.S.-origin encryption items. D. Deemed Exports The release to a foreign national of software source code (but not encryption source or object code) or technology (including encryption technology) is deemed to be an export to the country of origin of the foreign national, even if the release occurs in the United States. The release of software source code or technology includes visual inspection of such items by visiting foreign nationals or provision of technical assistance to foreign nationals. As a general rule, if an exporter needs a license to export software source code or technology to a particular country, then the exporter also needs a license to release such items to a foreign national of that country, even though the foreign national is located in the United States or a third country. E. Exportation of Encryption Items BIS maintains special controls on encryption items, such as encrypted hardware and software and encryption technology. In many cases, application must be made to BIS for a onetime review of the encrypted software before it can be exported. In addition, there are semiannual reporting requirements for the exportation of certain encrypted items. Posting encryption source code and object code on the Internet or making such code available for download to locations outside the United States is considered an exportation. 11

13 F. Penalties for Violations Penalties for violations of the EAR include denial of export privileges, fines, or in some cases imprisonment. Individuals and entities may face civil fines of up to the greater of $250,000 or twice the value of the transaction in which the violation occurred. Individuals and entities may face criminal fines of up to $1 million, and individuals may be sentenced to up to 20 years in prison. Since BIS publicizes the denial of export privileges and the imposition of fines, the corporate image of a violator may also suffer. III. The USA PATRIOT Act The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the USA PATRIOT Act or the PATRIOT Act ) brought about significant change to federal money laundering law requirements for a broad range of financial institutions, as defined by the Bank Secrecy Act ( BSA ). All financial institutions are required to undertake certain compliance procedures in accordance with implementing regulations, including the implementation of overall anti-money laundering ( AML ) programs, and procedures to verify the identity of customers. Certain categories of financial sector industries involved in financing, lending, securitization, and capital markets transactions are expressly enumerated, but not defined, in the BSA definition of financial institution. Specifically, these include (but are not limited to) the following categories: (i) banks and broker-dealers; (ii) insurance companies; (iii) investment bankers and investment companies, including unregistered investment companies; (iv) loan or finance companies; and (v) persons involved in real estate closings and settlements. The 12

14 Department of the Treasury ( Treasury ) is in the process of issuing industry-specific regulations that apply certain compliance obligations by industry and simultaneously define each industry. Banks, broker-dealers, and insurance companies have been addressed in final rules. The category of investment companies has been addressed by Treasury via final and proposed rules, though one set of proposed rules was withdrawn. Treasury also issued and then withdrew proposed rules to apply the PATRIOT Act to another category not specifically enumerated in the BSA: investment advisers. No regulations have been proposed or finalized for loan or finance companies or persons involved in real estate closings and settlements, though Treasury did issue advance notices of proposed rulemaking soliciting comments on certain aspects of the application of the PATRIOT Act to the latter category. A. Application to Financial Institutions 1. Banks and Broker-Dealers Banks and other depository institutions have had longstanding (pre-usa PATRIOT Act) AML obligations, imposed mainly by the BSA and guidance issued by federal functional regulators. Among the AML obligations that banks were required to undertake prior to the Act were the establishment and implementation of BSA compliance programs, including measures to identify customers. The BSA requirements closely resemble the USA PATRIOT Act s requirements for AML programs and customer identity verification. The regulations issued under the USA PATRIOT Act enhance the due diligence measures and expand the AML compliance programs that banks are required to undertake. Additional compliance obligations include the imposition of restrictions on private banking, correspondent, and shell banking relationships. 13

15 Prior to the enactment of the USA PATRIOT Act, broker-dealers had little in the way of formal AML obligations. Regulations issued after the enactment of the Act, however, rapidly imposed comprehensive compliance requirements, including requiring broker-dealers to (i) establish AML programs, (ii) establish customer identity verification programs, (iii) undertake measures to enhance due diligence for correspondent account relationships, and (iv) file suspicious activity reports. Certain requirements have also been imposed on futures commission merchants and introducing brokers in commodities. 2. Insurance Companies In imposing AML and suspicious activity report ( SAR ) requirements on insurance companies, Treasury limited the requirements to companies engaged in issuing or underwriting certain insurance products that Treasury considered most likely to pose a high risk of money laundering. Specifically, the requirements apply to permanent life insurance policies (other than group life insurance policies), annuity contracts (other than group annuity contracts), and any other insurance product with features of cash value or investment. The term insurance company does not include insurance agents and brokers, though insurance companies are responsible for integrating their agents and brokers into the companies AML and SAR programs. 3. Investment Companies The term investment company is not defined in the BSA, the PATRIOT Act, or their respective legislative histories. In implementing the BSA, Treasury has construed the term to include companies registered under the Investment Company Act as well as certain companies not required to be registered. Thus, Treasury has issued rules applicable to mutual funds to 14

16 establish AML compliance programs (interim final rule), to establish customer identity verification procedures (final rule), and to file SARs (final rule); and Treasury issued a proposed rule ( Proposed Rule ), withdrawn in 2008, that would have applied the AML compliance program requirement to unregistered investment companies. Companies that fall within this latter category would have been required to implement the AML program required by Section 352 of the USA PATRIOT Act and to file a notice with the Financial Crimes Enforcement Network ( FinCEN ), containing certain identifying information. The Proposed Rule was more relevant to hedge funds and actively managed shorter-term trading strategy funds than to other types of private investment funds, in particular many private equity funds, which would not likely have been covered. 4. Loan or Finance Companies The term loan or finance company is not defined in the BSA, the PATRIOT Act, or their respective legislative histories. Further, no regulations have been proposed or finalized that define or offer guidance on the scope of the term. 5. Persons Involved in Real Estate Closings and Settlements The term persons involved in real estate closings and settlements is not defined in the BSA, the PATRIOT Act, or their respective legislative histories. Further, no regulations have been proposed or finalized that define or offer guidance on the scope of the term. In 2003, Treasury published an advance notice of proposed rulemaking, soliciting initial comments on the application of the PATRIOT Act to persons involved in real estate closings and settlements. In 2009, Treasury published an advance notice of proposed rulemaking and 15

17 request for comments on the application of the PATRIOT Act to non-bank residential mortgage lenders and originators. 6. Investment Advisers The term investment adviser is not expressly included in the BSA s definition of financial institution. The BSA, however, confers upon Treasury the authority to include other businesses within the definition of financial institution so long as the activities of such business are similar to, related to, or a substitute for the activities of other financial institutions. Under that authority, Treasury published in 2003 a proposed rule ( Proposed IA Rule ) under Section 352 of the USA PATRIOT Act to require investment advisers ( IAs ) to establish AML programs. The Proposed IA Rule was withdrawn in The Proposed IA Rule would have applied the AML program requirement to any investment adviser, which was defined as: a person whose principal office and place of business is located in the United States that: (1) [i]s registered or required to be registered with the Securities and Exchange Commission under Section 203(a) of the Investment Advisers Act of 1940 and reports or is required to report in Part IA of SEC Form ADV that it has assets under management; or (2) [i]s exempt from registration with the SEC pursuant to section 203(b)(3) of the Investment Advisers Act and that would be required, if it were registered with the SEC, to report in Part IA of SEC Form ADV that it has $30 million or more of assets under management, unless such person is otherwise required to have an [AML] program pursuant to [other regulations issued under Section 352]. Thus, like the rules applicable to investment companies, the investment adviser rule would have covered businesses required to be registered as investment advisers as well as certain businesses that are exempt from such registration under the Investment Advisers Act. In addition to the AML program requirements, the Proposed IA Rule would have required 16

18 businesses that are not required to be registered as IAs due to an exemption under the Investment Advisers Act to provide certain information to FinCEN. B. Main Compliance Requirements The principal compliance obligations of the USA PATRIOT Act and the BSA are (i) the comprehensive AML program requirement, (ii) the customer identity verification procedure requirement, (iii) the heightened due diligence requirement for certain foreign and other accounts, and (iv) the suspicious activity filing requirement. Industry-specific implementing regulations have been proposed under certain of these requirements for some, but not all, financial institutions. 1. Anti-Money Laundering Program Section 352 of the USA PATRIOT Act requires all financial institutions to establish AML programs, which, at a minimum, must include four elements: (i) the development of internal policies, procedures, and controls; (ii) the designation of a compliance officer; (iii) an ongoing employee training program; and (iv) an independent audit function to test programs. The PATRIOT Act also requires Treasury, in consultation with federal functional regulators (which, for purposes of the PATRIOT Act, includes the Commodity Futures Trading Commission), to prescribe minimum standards for AML programs. The statutory effective date for compliance with Section 352 was originally April 24, 2002, but Treasury has deferred the deadline for industries as to which implementing regulations have yet to be issued. Thus, compliance with Section 352 by any particular institution is required when applicable industry-specific rules are finalized or issued in interim final form. 17

19 Final rules are currently in effect as to banks, broker-dealers, and insurance companies. Section 352 regulations have also been issued in interim final form for mutual funds. 2. Customer Identity Verification Section 326 of the USA PATRIOT Act requires Treasury and functional regulators to promulgate rules requiring identification verification procedures, which at a minimum must require financial institutions to implement, and customers to comply with, reasonable procedures for: (i) verifying the identity of any person seeking to open an account to the extent reasonable and practicable; (ii) maintaining records of the information used to verify a person s identity, including name, address, and other identifying information; and (iii) consulting lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency to determine whether a person seeking to open an account appears on any such list. At a minimum, an institution s customer identification program ( CIP ) should address the following: (i) customer identity verification procedures, including certain basic information (i.e., name, address, date of birth, and taxpayer identification number); (ii) verification of customer-provided information through documentary or non-documentary information; (iii) any additional verification methods for certain customers based upon the institution s assessment; (iv) comparison with government lists to determine whether the customer is a known or suspected terrorist; (v) notice to the customer regarding the request for information; and (vi) circumstances in which the institution will rely on another financial institution (with an AML program) to verify the customer s identity and to so certify. 18

20 Treasury, jointly with the appropriate federal functional regulators, has finalized customer identity regulations for the following types of institutions: banks, savings associations, credit unions, securities brokers and dealers, mutual funds, futures commission merchants, introducing brokers, and private banks and trust companies that do not have a federal regulator. The federal bank regulatory agencies have also issued interpretive guidance on customer identification program requirements under Section 326. The final rules cover accounts opened by customers at banks. An account is a formal banking relationship established to provide or engage in services, dealings, or other financial transactions including a deposit account, a transaction or asset account, a credit account, or other extension of credit. The term customer means (i) a person that opens a new account, or (ii) an individual who opens a new account for either an individual that lacks capacity or a legal entity that is not a person. 3. Heightened Due Diligence for Certain Foreign and Private Accounts The USA PATRIOT Act, inter alia, prohibits certain financial institutions from providing correspondent accounts to foreign shell banks and requires such financial institutions to take reasonable steps to ensure that correspondent accounts provided to foreign banks are not being used indirectly to serve foreign shell banks. Thus, financial institutions covered by the rules implementing these restrictions are required to employ enhanced due diligence procedures to ensure that their relationships with foreign entities are not shell bank relationships. Similar due diligence measures are required with respect to other financial relationships, including private banking and accounts of non-u.s. citizens. 19

21 Currently, the rules applicable to correspondent account due diligence only apply to banks, bank holding companies, other depository institutions, futures commission merchants, introducing brokers, and broker-dealers. However, these rules could be expanded to include other financial institutions in the future, especially in light of the USA PATRIOT Act s broad definition of correspondent account. 4. Suspicious Activity Reporting The BSA authorizes Treasury, in its discretion, to promulgate rules requiring financial institutions to file SARs for transactions that satisfy certain thresholds. Prior to the enactment of the USA PATRIOT Act, Treasury had issued such regulations for various industries, such as depository institutions and money transmitters. Section 356 of the USA PATRIOT Act requires Treasury, in consultation with the Federal Reserve Board and the Securities and Exchange Commission, to issue proposed regulations requiring registered broker-dealers to file SARs under the BSA. Similarly, the PATRIOT Act authorizes Treasury, in consultation with the Commodity Futures Trading Commission, to prescribe regulations requiring registered futures commission merchants, commodity trading advisors, and commodity pool operators to file SARs under the BSA. In 2002, Treasury issued a final rule requiring brokers and dealers to file SARs. In addition, subsequent to the passage of the USA PATRIOT Act and under its existing BSA authority, Treasury issued final rules requiring insurance companies, mutual funds, casinos, card clubs, currency dealers and exchangers, futures commission merchants, and money service businesses to file SARs. It is likely that, as Treasury perceives suspicious transactions to be occurring in a particular industry, it will accordingly require that industry to file SARs. 20

22 5. Special Designation of Countries or Accounts Section 311 of the USA PATRIOT Act grants Treasury authority to designate a foreign jurisdiction, institution(s), class(es) of transactions, or type(s) of account(s) to be of primary money laundering concern, and to require U.S. financial institutions to take certain special measures against the primary money laundering concern. Section 311 identifies factors to consider as well as agencies to consult before Treasury may designate a primary money laundering concern. Section 311 provides Treasury with a range of options that can be adapted to target specific money laundering and terrorist financing concerns. If Treasury determines that a foreign jurisdiction is of primary money laundering concern, then Treasury must determine the appropriate special measure(s) to address the specific money laundering risks. Section 311 provides a range of special measures that can be imposed, individually, jointly, in any combination, and in any sequence. Available special measures include requiring: (i) recordkeeping and reporting of certain financial transactions; (ii) collection of information relating to beneficial ownership; (iii) collection of information relating to certain payable-through accounts; (iv) collection of information relating to certain correspondent accounts; and (v) prohibition of or conditions on the opening or maintaining of correspondent or payable-through accounts. Treasury has used its authority under Section 311 to issue final regulations imposing special measures against several countries and banks, including Burma (Myanmar), Nauru, Ukraine, Myanmar Mayflower Bank, Asia Wealth Bank, Commercial Bank of Syria, Banco Delta Asia, and VEF Banka. Most of the regulations impose restrictions on the opening or maintaining of correspondent or payable-through accounts for the identified entities. 21

23 C. Penalties for Violations Violations of the PATRIOT Act s AML provisions, its due diligence requirements for correspondent accounts and private banking accounts, or its prohibition against U.S. correspondent accounts with foreign shell banks can incur civil or criminal fines of at least two times the value of the unlawful transaction, up to $1 million. IV. The U.S. Embargo Laws The United States maintains embargoes, or economic sanctions, targeted at specific countries, entities, and individuals. Embargo programs are administered by the Office of Foreign Assets Control ( OFAC ) within Treasury and impose restrictions on the activities of all persons subject to the jurisdiction of the United States ( U.S. Persons ). Each of the embargo programs has unique features and a separate set of implementing regulations. The OFAC website is located at A. Transactions with Embargoed Countries In general, the embargo programs prohibit U.S. Persons from engaging in virtually all transactions involving embargoed countries, unless a license is obtained from OFAC. Currently, comprehensive embargoes are maintained against Cuba, Iran, and Sudan. More limited restrictions are maintained against Belarus, Burma (Myanmar), North Korea, Syria, and Zimbabwe, as well as persons fomenting civil strife in the Balkans, the Democratic Republic of the Congo, Ivory Coast, Lebanon, and Liberia. The formerly comprehensive embargoes against Iraq and Libya were dismantled in recent years, though exports and re-exports to Iraq of certain items controlled by the EAR continue to require a license, and transactions with certain members 22

24 of the former regime are barred. The targets of embargoes are subject to abrupt change (as the examples of Iraq and Libya demonstrate); changes are publicized at the OFAC website. The definition of U.S. Persons varies among the different embargo programs. Under most of the programs, U.S. Persons includes U.S. citizens, permanent resident aliens of the United States, entities organized under the laws of the United States (including foreign branches), and any entities or individuals located in the United States. The embargoes of Cuba and North Korea also include in the definition of U.S. Persons any entities owned or controlled by other U.S. Persons, such as foreign subsidiaries of U.S. companies. 5 B. Transactions with Prohibited Entities and Individuals In addition to prohibiting U.S. Persons from engaging in transactions involving embargoed countries, the embargo programs prohibit transactions with certain entities and individuals determined to be affiliated with the governments of embargoed countries, as well as entities and individuals involved in certain activities of U.S. concern, such as terrorism, nuclear proliferation, and narcotics trafficking. The prohibited entities and individuals are identified on 5 Certain of the embargoes are supplemented by other sanctions laws with expansive extraterritorial application. For example, the Cuba embargo is bolstered by the Cuban Liberty and Democratic Solidarity (Libertad) Act of 1996, commonly known as the Helms-Burton Act. The Helms-Burton Act authorizes U.S. claimants, whose property was expropriated by the Cuban government and is being used by third-country companies, to sue those companies in U.S. federal courts for damages up to three times the current market value of the property. This right of action has been suspended by the President of the United States but could take effect at any time that the President decides no longer to suspend the provision. The Helms-Burton Act has also been applied to bar from the United States the directors and officers of third-country companies that are involved in the use of confiscated property in Cuba. The Iran embargo is reinforced by the Iran Sanctions Act, originally enacted in 1996 and extended in 2006 ( ISA ), which authorizes the imposition of sanctions whenever a third-country company invests over $20 million in any year in the petroleum resources sector of Iran. Congress is currently considering expanding the scope of ISA. 23

25 OFAC s list of Specially Designated Nationals and Blocked Persons ( the SDN List ), which is published on OFAC s website. Prior to engaging in any transactions with foreign entities or individuals, U.S. Persons are responsible for ensuring that such entities or individuals are not included on the SDN List. C. Prohibited Facilitation of Transactions Involving Foreign Entities U.S. Persons are also prohibited from facilitating transactions by a foreign entity, including a subsidiary or a foreign related company, with countries, entities, or individuals if the U.S. Persons themselves may not engage in the transactions due to embargo restrictions. Facilitation includes authorizing, supervising, managing, financing, or otherwise enabling such transactions. Thus, even a foreign entity not subject to the U.S. embargo programs may entangle its U.S. parent or affiliate in an embargo violation if the U.S. parent or affiliate facilitates a transaction by the foreign entity with an embargoed country, entity, or individual. Facilitation also includes referrals by a U.S. company to foreign entities of business opportunities that the embargoes bar the U.S. company from pursuing itself. In the banking context, OFAC has initiated a risk-based approach to enforcement and has also tended to attribute to U.S. branches knowledge that may be held by the foreign parent or foreign affiliates. Multi-million-dollar penalties were assessed against ABN AMRO in 2005, for example, for Iran transactions in which, apparently, the U.S. branch unwittingly participated. D. Prohibited Involvement by U.S. Citizens and Permanent Residents U.S. citizens and permanent residents, wherever located, are prohibited from engaging in transactions with embargoed countries. Thus, U.S. citizens and permanent residents employed abroad may not participate, through management, supervision, facilitation, or otherwise, in 24

26 transactions with embargoed countries, entities, or individuals. Furthermore, any U.S. citizens or permanent residents serving on the boards of directors of any entities must recuse themselves from any deliberations or authorizations relating to transactions with embargoed countries, entities, or individuals. E. Penalties for Violations Penalties for violations of the embargo programs vary according to the program; many penalties were increased by legislation enacted in Civil penalties range from $55,000 to $325,000 per violation. Criminal sanctions include fines of up to a range of $250,000 to $1 million for individuals and entities, and imprisonment of up to years. Other U.S. laws are sometimes invoked to augment the penalties available under the embargo laws. OFAC publishes on its website the names of parties subjected to penalties assessed or settled, including the amount of the penalty or settlement and the type of violation. V. Standard Provisions of Loan Agreements: International Trade Compliance Standard provisions of loan agreements (drawn from Model Form # 2 of the Note Purchase Agreement) crystallize some of the issues relating to international trade compliance in the lending context. Several such standard provisions follow, with accompanying commentary on international trade compliance implications. A. Representation and Warranty on General Compliance with Laws Section 5.6. Compliance with Laws, Other Instruments, Etc. 25

27 The execution, delivery and performance by the Company of this Agreement and the Notes will not... violate any provision of any statute or other rule or regulation of any Governmental Authority applicable to the Company or any Subsidiary. Comments: This provision may prove difficult for borrowers in Canada, the European Union, and Mexico, which have enacted so-called blocking statutes to bar companies in those jurisdictions from complying with the U.S. embargo against Cuba, including the Helms-Burton Act. To the extent that the loan agreement includes a covenant calling for compliance with U.S. embargo laws, the performance of the agreement by the borrower may violate a blocking statute applicable to the borrower. If the issue arises, one option may be to carve out Cuba from the covenant dealing with U.S. embargo laws and have a separate covenant against dealings with Cuba. B. Representation and Warranty on International Trade Compliance Laws Section Foreign Assets Control Regulations, Etc. (a) Neither the sale of the Notes by the Company hereunder nor its use of the proceeds thereof will violate the Trading with the Enemy Act, as amended, or any of the foreign assets control regulations of the United States Treasury Department (31 CFR, Subtitle B, Chapter V, as amended) or any enabling legislation or executive order relating thereto. (b) Neither the Company nor any Subsidiary (i) is a Person described or designated in the Specially Designated Nationals and Blocked Persons List of the Office of Foreign Assets Control or in Section 1 of the Anti-Terrorism Order or (ii) engages in any dealings or 26

28 transactions with any such Person. The Company and its Subsidiaries are in compliance, in all material respects, with the USA Patriot Act. (c) No part of the proceeds from the sale of the Notes hereunder will be used, directly or indirectly, for any payments to any governmental official or employee, political party, official of a political party, candidate for political office, or anyone else acting in an official capacity, in order to obtain, retain or direct business or obtain any improper advantage, in violation of the United States Foreign Corrupt Practices Act of 1977, as amended, assuming in all cases that such Act applies to the Company. Comments: This representation and warranty makes no mention of the EAR. Since violations of the EAR may result in denial of export privileges, which could damage the financial health of any business with material export operations, it may be prudent to include an EARspecific representation and warranty. The reference in (a) above to the Trading with the Enemy Act ( TWEA ) is superfluous in light of the inclusion of the embargo regulations; moreover, the TWEA is the statutory basis only for the embargoes of Cuba and North Korea. The warranty in (a) above is ambiguous insofar as it does not state whether it covers potential violations by the borrower only or also by the lender; if the borrower is a non-u.s. person, it could use proceeds in a transaction with a sanctioned country and not violate an embargo, while a U.S. lender might thereby be in violation. The reference in (b)(i) above to the Anti-Terrorism Order is superfluous in light of the reference to the SDN List, which is more inclusive. The warranty in (b)(ii) could be narrowed by a reference to constructive or actual knowledge and by a reference to use of proceeds, without materially increasing a lender s potential liability. Furthermore, the warranty in (b)(ii) would more effectively serve the lender s interests if it referred to dealings and 27