HGC CONSULTING PLUS

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About the Book - Chapter 1

History, Definition, and Scope of Sanctions

This is a book about sanctions: what they are, who they affect, why they (most likely) pose a risk to you, and how to minimize that risk. I eat, sleep, and breathe sanctions for a living, so I have a deep understanding of them. But since my goal here is to simplify a complex subject, I want to start with a very basic definition.

Britannica Dictionary defines “sanction” as “an action that is taken or an order that is given to force a country to obey international laws by limiting or stopping trade with that country, by not allowing economic aid for that country, etc.”1

As we will discuss shortly (and as I’ve already stated in the Introduction), sanctions are a much bigger deal than they were just a couple of decades ago. The events of 9/11 set in motion a huge expansion of the scope and extraterritorial reach of US sanctions—so much so that US law now applies to organizations in every corner of the globe. 

But first, let’s take a quick look at what sanctions are and how they’ve evolved up to this point.

Sanctions: A Brief Overview

In global politics, sanctions are a vital tool of governance. Most nations are familiar with sanctions. They’ve either used sanctions themselves or had sanctions used against them and their citizens. Sanctions are increasingly used in place of physical violence and are generally regarded as an alternative to war.2 Despite many discussions around (and differing opinions on) their true effectiveness, they’ve become a popular tool in peacekeeping, foreign relations, and conflict resolution.3,4

Depending on the actual situation, sanctions can either be preventive, or they can be a retroactive measure retaliating against a certain action. They allow a country to respond quickly to political challenges and developments that go against their goals and values. Sanctions target destructive and violent activities like:

  • Terrorism
  • Human rights violations
  • Drug and human trafficking
  • Cyber-attacks
  • Money laundering5

There are numerous types and forms of sanctions, far too many to cover in a book of this scope. Below are just a few you should be aware of:6

Economic sanctions: Commercial and financial penalties applied by one or more countries against a targeted self-governing state, group, or individual. (Please note: Technically and historically, tariffs are not regarded as sanctions. However, as we will see later in this book, both the Trump administration7 and the Biden administration8 have shown a lot of enthusiasm for using tariffs to pressure countries whose policies they oppose—the exact rationale behind the use of economic sanctions.)

International sanctions: Political and economic decisions that are connected to the diplomatic efforts of countries and multilateral or regional organizations.

Embargo/trade sanctions: While embargoes may involve a complete (or at least very broad) prohibition on trade or other economic activity with a particular country or group, trade sanctions have more specific targets.9 For example, according to Financial Crime Academy, trade sanctions can include prohibitions on “import, export, movement, transfer, making available or acquisition of goods and technology; the provision or procurement of services related to goods and technology; the provision or procurement of certain other non-financial services.”10

Diplomatic sanctions: Sanctions in which political measures are taken to express disapproval through diplomatic and political means, rather than affecting economic or military relations.

Anyone seeking to form a global compliance program will want to access the most updated lists of individual, country-wide, or corporate sanctions. The most relevant in this context are:

OFAC Sanctions
UN Sanctions
European Union/EU Sanctions
HM Treasury Sanctions (UK)/DFAT Sanctions (Australia)

Exercise: Learn Where to Find More Detailed Information on Forms of Sanctions

Please take a few minutes to do some of your own research on forms of sanctions and the various issuers of sanctions and spend a few minutes browsing content on the following websites:

Include “human rights sanctions” and “trade sanctions” in your search.

The Interesting History of Sanctions

Sanctions have likely existed in some form or fashion since the beginning of time. However, the earliest recorded sanction dates to 432 BC with the so-called “Megarian decree.” This occurred when traders from Megara were banned from entering the Athenian Empire’s harbors and markets. This had the desired effect of choking Megara’s economy.11

In the modern era, the “economic weapon” made its appearance in World War I. First came blockades: Britain and France used them to isolate Germany and its allies from the global economy. Blockades are not technically sanctions as they are a physical barrier rather than a legal one, but they are used to achieve the same ends. It was not until after WWI ended that sanctions gained serious consideration as an alternative to physical force and violence.

Nicholas Mulder, author of The Economic Weapon: The Rise of Sanctions as a Tool of Modern War, does a beautiful job of putting sanctions into context. He explains that the League of Nations, established by the Allied powers after WWI, “believed they had equipped the organization with a new and powerful kind of coercive instrument for the modern world.” That instrument was sanctions, described in 1919 by US president Woodrow Wilson as “something more tremendous than war”: the threat was “an absolute isolation…that brings a nation to its senses just as suffocation removes from the individual all inclinations to fight…Apply this economic, peaceful, silent, deadly remedy and there will be no need for force. It is a terrible remedy. It does not cost a life outside of the nation boycotted, but it brings a pressure upon that nation which, in my judgment, no modern nation could resist.”12 In the first decade of the League’s existence, the instrument described by Wilson was often referred to in English as “the economic weapon.”13 

After the League of Nations was replaced by the United Nations in 1945, sanctions were formally recognized by the UN as a foreign policy tool.14

Governments really ramped up the use of sanctions during the Cold War. The United States led the way. In the 1990s, unilateral sanctions were gradually replaced by multilateral, intergovernmental coalitions. Between 1990 and 2003, the UN imposed the most high-profile sanctions against Iraq.15 And since 1990, many sanctions have been aimed at political leaders, drug lords, and terrorists to reduce the humanitarian implications that have resulted from the Iraq sanctions.16

Then came September 11. In the weeks following the attacks on the World Trade Center, unparalleled counterterrorism measures were enforced among the UN’s 189 states. They were required to freeze the assets and limit the movement of designated terrorists and their supporters.17

Sanctions on Steroids: After 9/11, the Scope and Extraterritorial Reach of US Sanctions Ramp Up Sharply

As we are about to explore, 9/11 and the legislation and regulations that followed—Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism…also known as the USA PATRIOT Act—ushered in a bold new age in the sanctions arena. The idea that a domestic law requires extraterritorial application was an unprecedented move. Now, no matter where on the globe you are headquartered, even if you don’t have any operations in the US, you must think about OFAC sanctions.

At first glance, this may seem like a serious case of overreach on the part of the United States government. Yet the scope of the action makes sense when you consider that the US acted from a place of trauma. It had never experienced such an attack (at least in modern history) on its shores. Watch the following video if you need a reminder of the emotional impact of this terrible day. (But be warned: For some people, these images and words are triggering.)

A HARROWING VIDEO: Visit the Transportation Security Administration website at   https://www.tsa.gov/videos/911-events-unfold-0 to watch “9/11: As Events Unfold.”

 

Exercise: Guided Questions for Reflection

Please take a few minutes to reflect on your thoughts:

Questions for Everyone

  • Can you remember 9/11? If so, can you remember where you were?
  • What thoughts did you have? In the moment you heard it? On that day? Months after? Now?
  • What do sanctions, and especially OFAC sanctions, mean to you? Do you know what sanctions are? What do you think is their purpose? How effective do you think they are?

Questions for CEOs, Executives, Board Members

  • Do you recall what happened to the stock markets after 9/11?
  • Think about board conversations that happened shortly after 9/11. Did you have a business/disaster recovery plan in place? Did you follow it? What and with whom were your first conversations in executive meetings? What did you learn? What were your board members worried about? What would you as a board member or CEO be worried about now if something similar happened today—perhaps something in a different form such as a cyber-attack on the entire US, your country, or globally?
  • Remember which industries were affected most. Do you think the industry you are in is vulnerable—particularly to a similar event? How do you prepare?
  • Do you have a sanctions program in place? Do you think it helps? Does it help you? Does it help the global community/economy? Where do you think are its weaknesses? Do you think you need to do more?

Questions for Legislators/Lawmakers

  • Do you think we need to think about new tools given the risks posed by the use of Artificial Intelligence?
  • Any other thoughts?

Applicability and Scope of OFAC Sanctions: US Extraterritoriality

After the USA PATRIOT Act was passed, and executive orders and further legislation were adopted, the US was suddenly able to act outside its borders to a considerable degree (thus the term “extraterritorial” was coined for OFAC sanctions).18

How was this extraterritoriality development justified? More to the point, how is it thought of today? This passage from Iain Stewart’s Cross-Border Sanctions & AML sheds some light:

“US sanctions, anti-money laundering, and counterterrorist financing policies are rooted in the core belief that rogue actors should be prevented from access to the US global financial and transactional system in an era where the US dollar, at peak levels, can command 90% of all global forex transactions. There is now a multilateral agreement that rogue actors should not be able to access the international SWIFT transaction system based in Belgium, and a Global entity like the OECD’s FATF issuing global recommendations and standard to be complied with by all member countries.”19

For the purposes of this book, we are focusing on Office of Foreign Assets Control (OFAC) sanctions. These sanctions are far reaching, indeed. All US persons must comply with them. These include US citizens and permanent resident aliens (no matter where they are located). Likewise, all US incorporated entities and their foreign branches fall within the jurisdiction of OFAC sanctions.20

What’s more, the USA PATRIOT Act—Section 311 to be precise—widened the scope and extraterritorial application of sanctions even more by pointing to “the designation of jurisdictions, entities, and individuals of ‘primary money laundering concern.’”21 This expansion opened the door to almost unlimited possibility of application of Section 311 by broadening the definition of “financial institution.” As we will see shortly, this means that now every company or entity is at risk for fines, as long as it can be deemed “of primary money laundering concern.” 

How OFAC Applies to Various Industries

The bottom line: If anyone appears on OFAC’s “Specially Designated Nationals” (SDN) List, you can’t do business with them. By “you,” I mean every US citizen, permanent resident alien, or company, including any overseas branch of said company. The SDN List includes terrorists, narcotic traffickers, and anyone controlled by or acting on behalf of sanctioned countries.22 It is not difficult to see how easy it would be to accidentally “do business” with a prohibited person.

What’s more, after the events of 9/11, the USA PATRIOT Act broadened the definition of “financial institution” considerably. This increased OFAC’s role in national security exponentially.23 Now, “financial institutions” include such organizations as:

  • Vehicle Dealers and Vehicle Part Suppliers (including aircraft)
  • Casinos
  • Insurance
  • Real Estate and Construction
  • Travel and Tourism
  • Imports and Exports
  • Jewelry, Precious Gems, and Metal Dealers
  • Non-Profits and Charities
  • Money Service Businesses
  • Energy, Fossils
  • Technology, Fintechs, and Electronic Payments and Trading Entities
  • Transportation and Logistics Providers
  • Retailers, Distributors, Suppliers, and Manufacturers

NOTE: To learn more, read Computer Services, Inc. (CSI)’s white paper Understanding OFAC: A Best Practices Compliance Guide for All Businesses.24

When you look at this list, you may not be surprised to learn that the “other businesses” defined by OFAC as financial institutions greatly outnumber traditional banks. And those businesses are at risk for substantial fines. Consider that between 2006 and 2020, OFAC levied $5.68 billion in civil money penalties, or CMPs. While it’s true that banks are generally hit with the highest fines, non-traditional financial institutions typically make up the majority of the total number of fines imposed on a yearly basis. In fact, in the last 12 years, they were the recipients of 75 percent of all OFAC fines.25

Multimillion-Dollar Fines for Other Businesses Are Becoming More Common

Depending on the size of the business, the damage caused by these fines can be substantial. Even a large company will sustain a formidable financial setback. For a smaller business, such a fine is a catastrophe. It’s not hard to picture the disastrous fallout inflicted by these multimillion-dollar CMPs across a variety of industries:

  • Telecommunications Company: $100.9 million
  • Aerospace Services Provider: $50.9 million
  • Technology Company: $12 million
  • IT Services Company: $7.8 million
  • Manufacturer: $7.77 million
  • Money Services Business: $7.66 million
  • Pharmaceutical Firm: $7.62 million
  • Oil/Energy Provider: $5.97 million
  • Two Travel Services Providers: $5.9 million each
  • Chemical Manufacturer: $5.5 million
  • Agriculture/Seed Company: $4.32 million
  • Two Well-Known Multinational Conglomerates: $4.1 million and $2.7 million
  • Manufacturer: $4.07 million
  • Travel Services Provider: $2.8 million
  • Oilfield Services Provider: $2.77 million
  • Manufacturer: $2.06 million
  • Oil and Gas Company: $2 million

For more information on these OFAC fines and many others, read CSI’s white paper Understanding OFAC: A Best Practices Compliance Guide for All Businesses.26

What Is a “Transaction”?

OFAC utilizes a broad definition of “financial transaction” that encompasses “any transfer of value involving a financial institution.” According to OFAC’s website, the term “transaction” includes, but is not limited to, the following:

  • The provision of trade finance and/or letter of credit services for or with listed parties
  • The provision of guarantees or similar instruments for or with listed parties
  • The acceptance of commercial paper (both retail and wholesale) drawn on listed parties, and the clearance of such paper (including, but not limited to, checks and similar drafts)
  • The receipt or origination of wire transfers on behalf of or involving listed parties
  • The receipt or origination of ACH or ATM transactions with listed parties
  • The holding of nostro, vostro, or loro accounts for, or with, the Central Bank of Iran or designated banks, such as Bank Melli Iran and/or Bank Saderat Iran, including any of their branches or subsidiaries worldwide (collectively the “listed parties”)
  • The provision of investment products or instruments for listed parties and/or the participation with listed parties in investments
  • Any other transactions for, or on behalf of, directly or indirectly, listed parties and/or with listed parties serving as correspondents, respondents, or beneficiaries

That would include transactions where the listed parties do not appear on the face of the transaction, but where the transaction is undertaken with knowledge of the involvement of a listed party based on a relationship that exists through a third party such as a money exchange or trading house.27

According to CSI’s white paper Understanding OFAC: A Best Practices Compliance Guide for All Businesses: “Any business transaction could potentially violate OFAC, and there is no minimum dollar amount. However, certain transactions pose a higher risk, including but not limited to, those that are:

  • Initiated from foreign countries
  • Cash only, especially for large or luxury items that are easily liquidated
  • International wire transfers involving international parties
  • Real estate deals, especially where the seller or buyer isn’t personally known
  • Loan transactions, especially if the proceeds go to a third party
  • With entities known to conduct business in sanctioned countries
  • With a party that is anonymous or attempts to conceal their identity or location
  • Where the products bought or sold change hands multiple times, especially overseas.”28

…and What’s a Prohibited Transaction?

According to OFAC’s Treasury website, prohibited transactions are “trade or financial transactions and other dealings in which US persons may not engage unless authorized by OFAC or expressly exempted by statute. Because each program is based on different foreign policy and national security goals, prohibitions may vary between programs.”29 (As a reminder, “US persons” here also includes companies and their overseas branches, as well as other entities, jurisdictions, or individuals of “primary money laundering concern.”)

But is a prohibited transaction truly prohibited 100 percent of the time? No. OFAC does make exceptions. The website explains: “OFAC regulations often provide general licenses authorizing the performance of certain categories of transactions. OFAC also issues specific licenses on a case-by-case basis under certain limited situations and conditions. Guidance on how to request a specific license is found in Chapter 8 and at 31 C.F.R. 501.801.” To apply for a specific license, please go to https://ofac.treasury.gov/ofac-license-application-page.30

We will talk about how to apply for a license for certain, otherwise prohibited transactions later in this book.

Exercise: Direct Transactions and Facilitation/Direct and Indirect Risk

How can you know if your organization is involved in a “prohibited transaction”? Making sure you’re not directly engaged in a transaction is just the beginning. You also bear responsibility for the facilitation of transactions. That means screening your direct parties’ clients and other participants.

For example, in 2018, JPMorgan Chase Bank was fined $5.3 million for various sanctions violations in its capacity as a clearing bank for failing to screen participating member entities of the non-US entity that participated in a net settlement mechanism resolving airline industry billings. To learn more, read a client update by international law firm Davis Polk at https://www.davispolk.com/insights/client-update/ofac-enforcement-action-highlights-risk-indirect-sanctions-violations.

KEY TAKEAWAY: When providing settlement services, financial institutions need to be mindful not only of their clients, but also of their clients’ and clients’ counterparties’ underlying participants.

The reality is, you can be held liable not only for direct transactions, but also if you are part of an indirect transaction, e.g., by merely facilitating a transaction between your direct party’s clients and other participants, which may not be easily visible to you. Risk is particularly high during times of surging sanctions activity such as those that have recently been imposed due to the Ukrainian/Russian conflict.31

As we will discuss in Chapter 8, as sanctions surge and evolve, so do evasion techniques. You can end up being accused of facilitating sanctions evasion by dealing with a third party (who is dealing with another party that is your “fourth” party…and so on) that is somehow involved in the evasion of US sanctions. My advice is to do as much due diligence on your third party, fourth party, and subsequent providers as you possibly can. This is especially applicable if you are dealing in industries that are prone to sanctions and evasion techniques, such as oil and gas or luxury goods, and/or if you’re dealing with providers from countries or those that are connected with activities in countries that are notorious for aiding with the evasion of US sanctions, like the United Arab Emirates or China (to name only a few).

I hope this chapter has made clear how complex and intertwined the network of transactions undertaken by companies can be. It is all too easy for a well-intentioned organization to unknowingly commit an OFAC violation and end up being hit with crippling (even fatal) fines. That’s why most organizations—particularly large corporations that do business with overseas entities and/or operate in other countries—need to at least consider putting in place a robust global compliance program.

The OFAC website states that officials may look more favorably on an organization that shows up with a potential violation if it has a compliance program—and that the existence of this program might mitigate a CMP.32

It is better to be safe than sorry. Investing in a high-quality compliance program not only helps protect you from violations that you might make now, but also from those you might make in the future as your organization evolves and grows.

Case Study: Three Examples of What Happens When Companies Underestimate Extraterritoriality of US Sanctions 

BNP Paribas
In 2014, BNP Paribas was discovered to have violated US sanctions against Iran—and some against Sudan as well—and were charged an “astonishingly high figure” fine of $8.9 billion (given that its annual net income was $11.3 billion). This occurred despite the fact that transactions adhered to EU and French regulations, rules, and directives.33

Standard Chartered
In April 2019, Standard Chartered was hit with a penalty of $1.1 billion for “apparent violations” of US sanctions on Myanmar, Zimbabwe, Cuba, Sudan, Syria, and Iran between 2009 and 2014.34

Other
Commerzbank AG agreed to pay $1.45 billion over US sanctions against countries including Iran in 2015. US authorities said the German lender “turned a blind eye to money laundering and sanctions-busting violations.”35

Important Takeaways

  • All companies are at risk under OFAC. All companies should assess their OFAC risk exposure against their current and foreseeable business operations. It is a myth that only companies located in the US, banks or financial institutions, or companies dealing with controlled goods are at risk.
  • An OFAC compliance program is essential. OFAC’s settlement guidelines clearly state that a compliance program can be the most mitigating factor.
  • Large companies, especially those that are performing cross-border transactions, need robust OFAC compliance programs.
  • Pay attention to all types of OFAC sanctions: country, entity, and individual. OFAC sanction programs are directed at countries, designated persons or entities from these countries, as well as other individuals/entities included on the SDN List.
  • Facilitating a transaction is also an OFAC violation. OFAC sanctions programs not only target direct transactions, but also the facilitation of prohibited transactions. The facilitation does not need to be material or significant; even minor or indirect actions that support an unlawful transaction could constitute prohibited facilitation. Pay attention to potential sanctions evasion techniques you might be unknowingly facilitating through third parties.
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HGC CONSULTING PLUS

Specializing in training practitioners and advising senior leaders.

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