How U.S. and EU Sanctions Impact Funds and Asset Managers

Transcription

1 How U.S. and EU Sanctions Impact Funds and Asset Managers ICI and ICI Global Webinar August 7, #"45)%67%8"9:(% +(,#('*%--.% ;5)#<$9*"$0%+6%!"#$%&"''()*% +(,#('*%--.% -"$/"$0%12% 2012 Dechert LLP

2 Overview After today s webinar, you should have a general understanding of: The substantive provisions of U.S. and EU sanctions; The scope of persons that are required to comply with U.S. and EU sanctions; How U.S. and EU sanctions programs relate to the asset management industry; and Practical tools you can use to comply with U.S. and EU sanctions. 2

3 3 The Basics U.S. & EU Sanctions

4 Office of Foreign Assets Control (OFAC) Bureau of U.S. Treasury Department that administers most U.S. economic and trade sanctions. Charged with administering a variety of sanctions regimes imposed by statute, regulation or executive order. OFAC is the successor to the Foreign Funds Central (FFC) established at the advent of World War II to protect assets of Nazi-occupied countries. The use of economic sanctions to further U.S. foreign policy objectives expanded following World War II.! 1950: President Truman blocks North Korean and Chinese assets. OFAC established.! 1963: Cuban Embargo! 1979: Iran Sanctions! 1986: Anti-Apartheid Sanctions! Today: Numerous sanctions programs and expanding rapidly!. 4

5 EU Sanctions Architecture Key message: A confusing matrix of community level legislation which sets the EU legal/policy framework. Community legislation has direct effect in each EU Member State. However, responsibility for implementation is at a national level. A real challenge for funds operating across a range EU jurisdictions. Key points: -! Financial sanctions generally implemented through EU Regulations. -! Often follow UNSCR (e.g. Iran) but also autonomous (e.g. Syria). -! Can be country based or activity based (e.g. terrorism). -! Provide Annexes for EU SDNs. -! NB: No harmonization between EU and U.S. SDN lists. 5

6 Role of EU Member States Key message: Competent authority in each EU Member State has responsibility for interpretation, licensing, offences, enforcement and penalties. Key Member States UK (HM Treasury); Germany (Bundesbank); France (Tresor); and Italy (Central Bank). Key points: -! Nuances between Member States on interpretation. -! No Community licence. Branches need to consider host/parent. -! Some have over-arching legislation others separate instruments. -! Focus on enforcement and responsiveness mixed. -! NB: Overseas territories, e.g. BVI, Cayman Islands, etc. 6

7 Case Study London branch of a U.S. incorporated custodian bank. Acts as custodian for French asset management company. French asset management company manages two funds incorporated in the BVI. Funds are open to subscribers. However, 95% of both funds are made up of subscriptions from entities designated in both the EU and U.S. Authorisations to continue to manage and administer: -! United Kingdom (HM Treasury) -! France (Tresor) -! British Virgin Islands (Governor) -! United States (OFAC) NB: Licences come with record keeping, reporting and wider conditions 7

8 What do sanctions provisions prohibit? U.S. & EU sanctions generally prohibit a wide range of activities, which vary depending upon the targeted country or person. These prohibited activities generally include:! Exporting goods or services to, or importing goods or services from, or for the benefit of, an embargoed country;! Engaging in financial transactions with, or for the benefit of, the government of an embargoed country, or a person on the list of specially designated nationals ( SDN List );! Transferring money or any property to an entity or person in an embargoed country; and! Dealing in property in which the government of an embargoed country or a person or entity on the SDN List has an interest. 8

9 Targeted vs. Broad-Based Sanctions Certain sanctions programs are broad-based (e.g., Iran, Sudan and Syria) and preclude a wide range of transactions and activity with both the relevant country and individuals and entities within the country. On the other hand, certain sanctions programs target specific individuals and entities (e.g., Cote d Ivoire and Liberia) that have been identified by the European Union and the U.S. Government as engaging in undesirable conduct. The names of these targeted individuals and entities are generally included on the Specially Designated Nationals and Blocked Persons List ( SDN List ) or the EU Consolidated list of persons subject to financial sanctions, which are frequently updated. 9

10 Key U.S. Provisions: Asset Managers Prohibited Shareholders some examples:! Any person on the SDN List! Nationals of certain countries (e.g., Iran), subject to limitations! Persons owned 50% or more by an SDN Prohibited Investments some examples:! Sovereign debt of sanctioned jurisdictions (e.g., Iran)! Investments that finance sanctioned activities! Investments in issuers whose profits are derived predominately from sanctioned activity Extraterritorial application of U.S. sanctions on global asset management activities. 10

11 Key EU provisions: Asset Managers Key message: In general, EU asset freezing provisions appear relatively straight forward: (1) funds belonging to, owned, held or controlled by EU SDNs must be frozen and reported; and (2) funds are not to be made available, directly or indirectly, to or for the benefit of EU SDNs. Potential implications: -! How to identify beneficial owners and negotiation of nondisclosure agreements? -! Acquisition and disposal of securities in sanctioned entities? -! Administration and management fees of sanctioned fund? -! Investment in an entity engaged in certain destinations/sectors? -! What action to take if fund owner/controller is listed? 11

12 Compliance Challenges U.S. and EU provisions generally do not require persons to adopt compliance procedures, checklists, or to take any actions designed to cause compliance with sanctions obligations. However, U.S. persons and persons subject to EU sanctions generally face strict liability for any violation of applicable sanctions. Even firms with the best sanctions compliance programs are liable if they inadvertently effect a prohibited transaction. And financial regulators are increasingly focused on financial institutions adopting robust sanctions policies and procedures as part of AML risk management. 12

13 Poll Question #1 What is your firm s AUM for regulated funds? (a)!less than $5 billion USD (b)!between $5 and $50 billion USD (c)!more than $50 billion USD (d)!not applicable 13

14 Overview of U.S. Sanctions Programs Sanctions are based on a variety of different constitutional and statutory authorities. Examples of Relevant Statutes:! Trading with the Enemy Act! International Emergency Economic Powers Act! Iran Sanctions Act / CISADA! National Defense Authorization Act for FY 2012 Scope of sanctions programs may vary significantly. 14

15 U.S.: Who must comply? United States persons, wherever located!! Companies/funds organized under the laws of the United States or any state! United States citizens or permanent residents, wherever located! Branches/offices of non-u.s. companies located in the United States Certain sanctions programs apply more broadly!. 15

16 Scope of application: EU Persons Key message: Scope of U.S. sanctions often perceived to be far wider than that of EU sanctions. Not always the case. Undoubtedly U.S. enforcement agencies continue to take a far more proactive and aggressive approach to potential sanctions violations. However, it s a myth that only U.S. sanctions provisions have extra-territorial application. In general, EU restrictive measures apply: within the territory of the Union, including its airspace. Any activity which takes place within the EU, e.g. actions of any custodian, trustee, manager, other service provider located in EU. to any person...who is a national of a Member State. All EU nationals employed by financial institutions wherever located are personally liable for offences under national legislation. 16

17 Scope of application: EU Persons In general, EU restrictive measures apply: to any entity...which is incorporated under EU law. Any U.S. branch of an EU incorporated asset manager must comply with U.S. and EU sanctions provisions. to any business done in whole or in part within the Union. Any activity which takes place within the EU (e.g. any activity undertaken by an employee of U.S. firm whilst visiting the EU). 17

18 Case study UK national employed by a U.S. incorporated investment advisor located in NY. UK national advises U.S. client to participate in an IPO of an entity which has minimal risk from a U.S. sanctions. However, UK national is aware of wider due diligence which indicates that the entity is owned/controlled by an individual subject to EU asset freezing provisions. Key considerations: -! UK national subject to UK/EU sanctions wherever located. -! UK prohibits making funds available for the benefit of an SDN. -! UK national has reasonable cause to suspect. -! No corporate liability but reputational risks need to be managed. 18

19 U.S. SDN List List of specially designated nationals subject to U.S. sanctions:! Designated terrorists and terrorist organizations! Designated narcotics traffickers! Designated criminal organizations! Persons designated under certain country specific sanctions programs (e.g., Zimbabwe, Belarus) United States persons are required to block all property of an SDN in their possession or control. OFAC Guidance: persons in which an SDN has a 50% > interest are also blocked. 19

20 EU Sanctions Targets The EU consolidated list of persons, groups and entities subject to Common Foreign and Security Policy related financial sanctions The consolidated list of asset freeze targets designated by the United Nations, European Union and United Kingdom under current financial sanctions regimes 20

21 SDN List " U.S. & EU Sanctions Some people mistakenly confuse the SDN List with the full range of persons subject to U.S. & EU sanctions In fact, U.S. & EU sanctions apply to a much broader universe of persons than appear on the SDN List:! Owned or controlled; or! Acting on behalf of; or! Acting to or for the benefit of. 21

22 Example: Iran and Syria Sanctions Prohibition on United States persons providing any goods or services to Iran or Syria. Examples of prohibited conduct:! New investments by United States persons in Iran or Syria Iranian or Syrian sovereign debt Companies domiciled in Iran/Syrian or organized under Iranian/ Syrian law! Providing services to Iranian/Syrian nationals where the benefit of such services would be received in Iran/Syria Hypothetical! Fund shareholder indicates he is an Iranian national but lives in the United States. 22

23 Other Sanctions Programs Burma/Myanmar! Embargo recently relaxed to permit new investments, subject to reporting with the Department of State. Sudan! Broad embargo; unlawful to provide goods or services to Sudan. North Korea! Prohibition on dealing with North Korean government; importing goods or services from North Korea. Prohibitions generally apply to United States persons! 23

24 Cuban Sanctions Program Broadly prohibits person subject to the jurisdiction of the United States from exporting or importing goods or services to or from Cuba and from engaging in transactions with Cuba or Cuban nationals (wherever located):! Arguably the most controversial sanctions regime due to its tenure, significant scope, and extraterritorial applications; and! Many countries block extraterritorial application. 24

25 EU Blocking Statutes Prohibit EU firms from compliance with U.S. sanctions where no corresponding EU sanctions provisions and compliance leads to economic disadvantage. Arguably becoming less relevant given increased harmonisation between EU and U.S. on sanctions issues (exception of Cuba). Sanctions compliance or risk appetite? 25

26 Poll Question #2 An EU subsidiary of a U.S. company is forced to choose between complying with U.S. sanctions against Cuba, or complying with EU blocking measures. What should it do? A)! Comply with EU law B)!Comply with U.S. law C)!Contact OFAC or relevant EU authorities for guidance 26

27 The Challenge of Prohibited Facilitation Iranian Sanctions Regime:! Prohibits U.S. persons from engaging in certain financial dealings with Iran; and! No U.S. person may approve, finance, facilitate, or guarantee any transaction by a foreign person where the transaction by that foreign person would be prohibited! if performed by a United States person or within the United States. Burmese Sanctions Regime:! Restricts the expert and import of goods and services to and from Burma by U.S. persons;! Prohibits new investment in Burma; and! Prohibits approval or other facilitation, including assisting and supporting, by a U.S. person of a new investment in Burma. Sudanese Sanctions Regime:! Restricts import and export of goods and services to and from Sudan by a U.S. person;! Restricts financial dealings with Sudan; and! Prohibits facilitation by a U.S. person of a transaction by a foreign person where the transaction would constitute prohibited financial dealing with Sudan, if engaged in by a U.S. person or within the U.S. 27

28 Recent Trend Focus on Non-US Financial Institutions Allegation: Unlawfully exporting financial services from the United States! ING Bank, HSBC: Stripping Allegations.! Most USD-denominated transfers necessarily involve the intermediation of a U.S. financial institution (e.g., a correspondent bank) to clear the transaction.! If a U.S. financial institution is used to provide services for the benefit of a sanctioned person, then an OFAC violation occurs. 28

29 Circumvention Key message: Similar to U.S. facilitation provisions, EU sanctions provisions prohibit the participation, knowingly and intentionally, in activities the object of which is to circumvent asset freezing and wider sanctions measures. Key points: -! EU financial institutions cannot alter operating policies or procedures to permit a foreign subsidiary to do business that the EU firm cannot undertake due to sanctions considerations. -! Many examples where fund managers have had to file voluntary disclosures for transferring back office activities to overseas territories. -! Circumvention prohibitions and corresponding offences and penalties bite on both a corporate level and personal/individual liability basis. 29

30 Case Studies Sanctioned Investor! U.S. fund! Non-U.S. fund managed by U.S. person IPO for non-us company to raise funds for expansion in sanctioned jurisdictions. Investment in non-us company whose profits are derived predominantly from sanctioned activity. Sanctioned investor in USD share class of non-u.s. fund. 30

31 Recent U.S. Case Investment manager organized under the laws of Delaware ( U.S. Advisor ) served as the advisor to a Guernsey-organized investment fund. The U.S. Advisor contracted with its U.K.- organized subsidiary to act as the sub-advisor for the Guernsey fund. Pursuant to its delegated authority, the U.K. subsidiary authorized the purchase of $3 million of shares in First Persian Equity Fund ( Persian Fund ), a Cayman Islands company that invests exclusively in Iranian securities, for the Guernsey fund. 31

32 Alleged Violation of U.S. Law The Iranian Transaction Regulations do not apply directly to non-u.s. persons. The transaction at issue was made by a non-u.s. fund on the instruction of a non-u.s. sub-advisor. Nevertheless, OFAC alleged that the U.S. Advisor violated the Iranian Transaction Regulations as a result of the Guernsey fund s investment in the Persian Fund. 32

33 The Settlement The U.S. Advisor paid $112,500 to settle potential civil liability. In determining the appropriate settlement OFAC considered, among other things, that the U.S. Advisor did not have an OFAC compliance program in place and that its officers were aware of the conduct giving rise to the violation. 33

34 Lessons for Asset Management Firms U.S. asset managers may be held ultimately liable for investment decisions made by non-u.s. subadvisors. U.S. asset managers need to ensure that their non-u.s. sub-advisors are complying with U.S. law, even in cases where the U.S. regulations do not apply directly to the fund or sub-advisor. All U.S. asset managers should have an OFAC compliance program in place, which includes riskbased procedures for assessing whether portfolio holdings implicate OFAC sanctions. 34

35 Case Study Netherlands incorporated subsidiary of U.S. portfolio management company. Subsidiary operates wholly independently from parent and manages a global portfolio which includes securities listed on the Zimbabwe stock exchange. Portfolio includes significant number securities in a designated Zimbabwean mining company. Discussion: -! Can the subsidiary receive dividend payments from its interest in the listed Zimbabwean mining company? NB: No prohibition on receiving funds from a SDN. -! Can the subsidiary increase its interest in the listed Zimbabwean mining company by purchasing new shares from the Company? NB: Prohibition dealing with funds owned by a designated person. 35

36 Poll Question #3 Does your organization operate a global sanctions compliance program sufficiently flexible to accommodate both U.S. and EU considerations? (a)!yes (b)!no (c)!don t know (d)!not applicable 36

37 37 Licenses and Enforcement

38 Exemptions General License! Authorizes the performance of certain categories of transactions without filing an application with OFAC or relevant competent EU regulatory body. Specific License! Issued by OFAC or EU Member State on a case-bycase basis to a specific individual or company.! Allows an activity that would otherwise by prohibited by a sanctions regime. 38

39 U.S. Enforcement Actions No Action Request for Additional Information Cautionary Letter Finding of Violations! Civil monetary penalty! Settlement can be initiated by OFAC or the party Criminal Referral Other Administrative Actions 39

40 Civil Monetary Penalty In EU varies between Member States. E.g. in UK potential penalties = seven year imprisonment and unlimited fine. In U.S. base penalty calculation range from $1,000 to $250,000 per violation! Is the case deemed egregious or non-egregious?! Did the apparent violation come to the attention of OFAC through voluntary self-disclosure or other means? Non-Egregious Egregious Voluntary Self- Disclosure No Voluntary Self- Disclosure # of the transaction value (capped at $125,000 per violation) Applicable schedule amount (capped at $250,000 per violation) # of the statutory maximum Statutory maximum 40

41 Factors in Determining Penalty Willful or Reckless Violation; Awareness of Underlying Conduct; Harm to Sanctions Program Objectives; Individual Characteristics of the Individual or Entity; Existence and Nature of Compliance Program; Remedial Response; Cooperation with OFAC and/or EU authorities; Other Enforcement Actions; and Future Compliance / Deterrent Effect. 41

42 42 Compliance Tools

43 Oversight and Enforcement Considerations Considerations for U.S. funds and advisers! Outside the scope of the US Bank Secrecy Act; therefore, not required to be part of a fund s or adviser s AML program! If sanctions procedures are part of a fund s AML program, then they are subject to review by the SEC and noncompliance may result in SEC or FinCEN proceedings 43

44 Developing a Compliance Program Elements of a compliance program! Screening investors by transfer agent or other parties.! Representations and warranties from intermediaries. Issue: Difficulty in screening investments! Lack of reliable trade clearance programs.! Potential solution: employee training.! Potential solution: reliance on underwriters.! Essential to take a risk-based approach. 44

45 Representations and Warranties Common issues:! Confusing SDN List with broader sanctions programs E.g., representation to not deal with a person on the SDN List " sanctions compliance.! Knowledge qualifiers Difficult negotiation in light of strict liability for compliance! Overbroad representations Counterparties seeking unreasonable representations (e.g., no sanctioned person has an interest in the investor) when the appropriate representation is that dealing with the investor would not cause a violation of sanctions! Notification and reasonable assistance If there is an issue, you want your counterparty to call you first 45

46 !"#"$%&'()*+&,%#-"'(.&/.$"' 0$%#1%-2)#%&'()*+&,%#-"' 34%$"#"11'5%,1,#6' PHASE I Initial Assessment PHASE II Risk Assessment PHASE III Systems Policies Procedures PHASE IV Due Diligence PHASE V Contracts PHASE VI Training PHASE VII Audit Tailored Compliance Questionnarie sent to all staff Targeted interviews based on Questionnaire results Collection of results Identifying risks specific to: The jurisdictions in which company operates Products and services offered by the company Partners with whom company operates 3 rd party contracts Employee awareness & understanding Compliance comprehensive risk report identifying high, medium flow risks Based on the comprehensive risk assessment produced targeted policies and procedures to manage key risks Work with company to develop robust internal systems to ensure compliance with policies and procedures Work with company to develop enhanced due diligence intended for any sensitive transactions Establish comprehensive due diligence procedures fully integrated with policies and procedures Review a sample of company s past financial transactions Review current contractual provisions and general T&Cs Draft key compliance clauses for inclusion and contracts Update existing contracts Stage 1 In person or webinar training for all staff Stage 2 Focused training employees in person Stage 3 Board training in person Stage 4 Testing of knowledge Initial audit 6 months after deployment of compliance programme to identify key gaps in compliance Targeted audit on areas where gaps identified Development of remedial reports Provide report & recommendations to the board Stage 5 Refresher training 1-1/2 months 1 month 1 month 2 months 2-3 months Ongoing

47 47 Recent Developments

48 Enforcement and Penalties Key message: Clear indication that UK and other EU jurisdictions taking enforcement more seriously. April 2009, FSA review of UK financial institutions approach to sanctions risk. UK firms prohibited from supplying services to sanctions targets. Money Laundering Regulations 2007 require firms to have adequate risk management procedures. Key figures: -! March 2012, HMRC (enforcement arm of HM Treasury) announces 84 UK companies had breached Iran sanctions in previous year. -! March 2012, FSA fines Coutts 8.75m for failures in risk management inc. establishing wealth & source of funds of clients. -! August 2010, FSA fines RBS 5.6m for failures in systems and controls with respect to UK financial sanctions risk. 48

49 Iran Sanctions Development Designed to apply U.S. sanctions extraterritorially. CISADA: Requires the Treasury Department to prohibit, or impose strict conditions on, the opening or maintaining in the United States of a correspondent account or a payable-through account for a foreign financial institution that the Secretary of the Treasury finds knowingly engages in specified sanctionable activities. NDAA: Requires the President to prohibit the opening, and prohibit or impose strict conditions on the maintaining, in the United States of a correspondent account or a payable-through account by a foreign financial institution that the President determines has knowingly conducted or facilitated any significant financial transaction with the Central Bank of Iran or another Iranian financial institution that is an SDN. 49

50 CISADA and SAA Protections for Divestment CISADA and SAA provide a safe harbor for asset managers that divest from, or avoid investment in, securities issued by persons that engage in prohibited investment activities in Iran or Sudan. Certain U.S. institutional investors may divest plan assets from, or avoid investing plan assets in, persons it determines engage in prohibited investment activities in Iran or Sudan without breaching its fiduciary duties, if:! the fiduciary makes such determination using credible public information; and! the fiduciary prudently determines that the result of such divestment or avoidance of investment would not be expected to provide the plan with either a lower rate of return, or a higher degree of risk, than alternative investments with commensurate degrees of risk and rates of return 50

51 Pending Legislation President Obama will soon sign into law the Iran Sanctions, Accountability and Human Rights Act of 2012.! Requires the President to "prohibit an entity owned or controlled by a United States person and established or maintained outside the United States from knowingly engaging in any transaction directly or indirectly with the Government of Iran or any person subject to the jurisdiction of that Government that would be prohibited... if the transaction were engaged in by a United States person or in the United States." To avoid penalties, a U.S. entity has 180 days after the Act is signed to "divest" or "terminate" its business with the foreign subsidiary.! Requires companies (U.S. and non-u.s.) whose securities are registered with the U.S. Securities and Exchange Commission to disclose if the company or any affiliate has knowingly engaged in certain Iran-related activities. The disclosure to the SEC would require "a detailed description of each such activity," including the nature and extent of the activities; the gross revenues and net profits attributable to the activities; and whether the activity will be continued. 51

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