Of Counsel
Making Sure Today’s Foreign Investment Does Not Become Tomorrow’s Sanctions Violation
03 May 2016

In this article, Adam S. Kaufmann, A. Katherine Toomey , and Mirella A. deRose of Lewis Baach pllc, discuss the risk for U.S. businesses of falling foul of U.S. sanctions legislation through not just what they do directly, but also through transactions that they participate in, assist or supervise.

In early March, 2016, it was reported that Yorkville Advisors, LLC (Yorkville), a New Jersey based hedge fund advisory firm, is under investigation for potential violations of U.S. sanctions targeting Sudan.  Between August 2012 and July 2015, Yorkville Global Master SPV Ltd. (Yorkville Global Master), a Cayman Islands investment fund and special purpose vehicle created by Yorkville, invested almost $8 million in Regency Mines plc (Regency), a U.K. based mining company.

Regency in turn obtained an ownership interest in International Mineral Resources (Agrominerals Sudan) Limited (IMRAS), which has concessions from the Sudanese government allowing it to explore and develop agromineral prospects on government land in Sudan.  In connection with their joint venture, Regency and IMRAS worked closely with Sudanese government employees, including geologists from the Ministry of Minerals, who helped identify and explore potential project sites.

The Sudanese government has actively promoted mining operations since July 2011 when South Sudan seceded, taking with it the majority of oil producing territory and a third of Sudan’s former revenues.  However, since 1997 comprehensive U.S. sanctions against Sudan have precluded U.S. companies from participating in such operations.  Under the Sudan sanctions program, “U.S. persons” – that is, companies incorporated or headquartered in the U.S., including their foreign branches, and all U.S. citizens and permanent residents – are generally prohibited from doing business with persons in Sudan.  See generally 31 C.F.R. §538.  U.S. persons are also prohibited from facilitating transactions by others that would be illegal if undertaken by a U.S. person and from evading the sanctions.  31 C.F.R. §§538.206, 538.211.  Sudan sanctions do not apply to foreign subsidiaries of U.S. companies.  See 31 C.F.R. §538.315 (defining “U.S. Person”).

The Yorkville situation illustrates an important risk for U.S. businesses in general and U.S. investment and securities companies in particular.  U.S. businesses (and any U.S. citizen or permanent resident, wherever located) can be liable not just for what they do directly, but also for any transaction that they participate in, assist or supervise.  31 C.F.R. §538.407.  In unrelated fraud proceedings, the Securities Exchange Commission has asserted that Yorkville’s founder and president Mark Angelo was the portfolio manager for Yorkville’s offshore funds, responsible for overseeing all aspects of the funds’ day-to-day operations.  If true, this may present problems for Yorkville (and Mr. Angelo) in the Sudan sanctions investigation.  Because U.S. persons are precluded from doing business with Sudan and are further precluded from facilitating or participating in any such business, neither Yorkville nor Mr. Angelo could have legally directed, participated in or approved the investment of funds, directly or indirectly, in Sudanese businesses.  Yorkville has denied the fraud allegations but has not taken a public position on its role in managing offshore funds.

A similar circumstance arose in connection with the United States’ Iran sanctions program.  In that case, OFAC found that a U.S. investment manager violated sanctions pertaining to Iran when it delegated authority to conduct transactions in a fund under its management to a London-based subsidiary, and that subsidiary then purchased shares of a Cayman Islands-based fund that invested exclusively in Iranian securities.  Unlike in the case of Sudan sanctions, Iran sanctions in place at the time expressly precluded foreign subsidiaries of U.S. companies from doing business that their U.S. parent company could not do.  Crucial here is that the U.S. investment manager’s ignorance of its OFAC obligations did not shield it from civil liability.  OFAC sanction violations are assessed under a regime of strict liability: an entity that violates OFAC sanctions is liable regardless of whether the violator knew of or intended to commit the violation.  So, consistent monitoring of ongoing investment decisions by subsidiaries, as well as tracking changes in the scope of applicable sanctions is critical for any investment advisor, hedge fund, or private equity group.

Each of these incidents demonstrates a risk that U.S. companies face in respect of their foreign operations.  Because U.S. sanctions, in general, apply only to the conduct of U.S. persons, there may be a temptation for firms to try to structure otherwise prohibited transactions through foreign subsidiaries not ordinarily subject to the sanctions regime.  But “outsourcing” otherwise illegal transactions to an offshore subsidiary is a very dangerous business tactic that may well expose the U.S. firm and its U.S. employees and officers to liability for sanctions violations.  This is because U.S. sanctions programs not only prohibit U.S. entities and persons from undertaking a transaction with a sanctioned country, they also prohibit U.S. persons and entities from facilitating or participating in such a transaction.  So a U.S. company with a foreign subsidiary would have to ensure that neither the U.S. parent, nor any individual U.S. citizen or resident, had any involvement in any transactions with a sanctioned country, person or entity.  31 C.F.R. §538.407.  Because U.S. persons are also prohibited from evading a sanctions program, a U.S. company could also run afoul of sanctions if the idea for the transaction came from the U.S. parent and was assigned or referred to the foreign subsidiary to avoid sanctions.  Id. at subsection (d).

A carefully crafted and implemented OFAC sanctions compliance program is critical to avoiding civil monetary penalties of up to twice the amount of the transaction and parallel criminal penalties of up to $1,000,000 and/or imprisonment for up to 20 years for willful violations.  Investment managers, hedge funds and private equity funds must identify and assess the sanctions risks they face and develop OFAC compliance programs to mitigate those risks based on each company’s unique business.  If an OFAC Enforcement action arises, the entity’s demonstrated efforts to prevent sanctions violations will play a crucial role in OFAC’s determination of penalties.  Penalties for systematic or willful non-compliance with sanctions regulations can be devastating.  In 2014, BNP Paribas was fined a record $8.9 billion and sentenced to five years probation for flouting sanctions against Sudan, Cuba and Iran.

Given the dynamic nature of U.S. sanctions regulations and the severity of the penalties for even unintentional violations, coupled with the complex global transactions that characterize the securities and investment sector today, a bespoke OFAC sanctions compliance program is essential to ensure that today’s foreign investment does not become tomorrow’s sanctions violation.  Attorneys with experience crafting sanctions compliance programs and who stay current on developments in OFAC regulations can help guide today’s investment funds to profitable territory in treacherous international waters.

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