OFAC Now Requires U.S. Persons to Report Any Transaction They Reject Due to Sanctions
In a surprising move, the Office of Foreign Assets Control (OFAC) has imposed a new reporting requirement on U.S. persons that is far more expansive than at first it may appear.
OFAC's Reporting, Procedures and Penalties Regulations require U.S. persons, including financial institutions, to file reports when a transaction is "blocked" and when a transaction is "rejected." On Friday, June 21, 2019, OFAC announced a variety of amendments to these Regulations.1 The most significant change is a revision of 31 C.F.R. § 501.604, which broadens the scope of the 10-day reporting requirement for "rejected" transactions. This reporting requirement has been expanded in two key ways. First, the amendment clarifies that the reporting requirement applies not only to "rejected funds transfers," but also to any transaction rejected because it would violate sanctions, including transactions "related to wire transfers, trade finance, securities, checks, foreign exchange, and goods or services." Second, whereas § 501.604 used to apply only to U.S. financial institutions, the amendment now expands the reporting requirement to "any U.S. person"—not only U.S. financial institutions—but any U.S. citizen, green card holder, protected individual, or entity incorporated or registered in the U.S. (and foreign branches).
This constitutes a major change for any US businesses outside of the financial sector and may require many, many, more reports to OFAC than were previously required.
Blocking v. Rejecting
The significant change in the regulations draws on the pre-existing distinction between transactions that are "blocked," as opposed to transactions that are "rejected." The more significant changes in the new regulations relate to rejecting, as opposed to blocking. When a transaction is blocked, it means that the property at issue must be frozen and held in place, e.g., the bank must hold onto the funds at issue until instructed otherwise by OFAC. By contrast, when a transaction or transfer is "rejected," it is not held in place but is essentially returned to sender.
Some prohibited transactions must be blocked, while others need only be rejected. Property must be "blocked" when the transaction involves an entity that has been added to OFAC's list of Specially Designated Nationals (SDNs). But OFAC has many restrictions that do not involve SDNs. For example, transactions with Iranian businesses are almost uniformly prohibited, but not all Iranian businesses are SDNs. A bank processing a wire transfer to an Iranian business that is not on the SDN list must reject the transaction but it is not required to block the transaction.
The new regulations expand the reporting requirement both for blocking and rejecting, but significantly more in cases involving rejecting. Whereas in the past, OFAC reporting requirements had always been the most stringent in the context of blocking,2 the requirements have now become more stringent in context of rejecting. The amendments in the blocking context include a revision that specifies the specific types of information submitters must include in initial blocking reports, annual reports on blocked property, and reports on property that is unblocked. But those changes were far less significant than the changes to the reporting requirement in the rejection context.
Every U.S. Person Must Now Report All "Rejected" Transactions
With the amendment to the regulations, the reporting requirements apply to all rejected transactions, not just to a bank's rejection of a fund transfer. Thus, as of June 21, if a U.S. person "rejects" a transaction involving the provision of goods or services, for example, that U.S. person must file a report with OFAC. In other words, now all U.S. businesses—not only U.S. financial institutions—must report "rejected transactions" to OFAC within 10 days, "where processing or engaging in the transaction would nonetheless violate" OFAC sanctions despite the transaction not involving formally "blocked" property.
The new regulations mean that anyone (not just banks processing funds transfers) who rejects a transaction because it involves a sanctioned territory like Iran, Syria, Cuba, or Crimea, or it indirectly involves an OFAC listed person, such as someone listed on the SDN list (and does not require blocking because no property was ever transferred to the control of a U.S. person) may be obligated to report this rejection, even if the transaction went no further than an offer and a refusal, or otherwise did not involve any transfer of property that must be blocked by the U.S. person.
For example, OFAC Frequently Asked Question (FAQ) #36 provides an example of a "rejected funds transfer" that met the prior reporting requirement:
A U.S. bank interdicts a commercial payment destined for the account of ABC Import-Export at [Syrian] French Bank, [Damascus, Syria]. Unlike the Bank of XYZ, [Syrian] French Bank, [Damascus] is a private sector entity so there is no blockable interest in this payment. However, processing the payment would mean facilitating trade with [Syria] and providing a service in support of a commercial transaction in [Syria], therefore the U.S. bank must reject the payment.3
While it was clear under the old rule that this amounted to a transaction that would have to be reported, the new rule goes further. Now, even if the rejection involves a shipment of goods, as opposed to a transfer of funds, the rejection needs to be reported. And it needs to be reported by any U.S. person involved, not just by a bank.
The New Reporting Requirement is Ambiguous
Unfortunately, the new rule replaces the clarity of the old rule with ambiguity. Rejection is a relatively clear concept when applied to a bank and the transfer of funds. But what does it mean when extended to all U.S. persons, and extended to transactions that generally involve goods and services?
Under the new rule, suppose an employee of a U.S. company proposes a plan to his manager that involves the production and export of widgets to Syria, and the manager says, "No, we are not allowed to export to Syria." Is that a rejection of a transaction involving goods that now must be reported to OFAC? What if, instead, the manager drafts a proposal related to the plan and circulates it internally, and only after the compliance department intervenes does the company stop action on the plan? Is that a "rejection" that triggers the reporting requirement? Is it only a reportable "rejection" if a third party is somehow involved?
In other words, when does a "rejection" of a "transaction" occur such that the reporting requirement is triggered? There is no guidance on what constitutions a rejection, including the line between a U.S. person's informal decision not to pursue a transaction as opposed to a formal "rejection" requiring a report, nor is there any guidance on what constitutes a "transaction" in this context.
Potential Impact and Opportunity to Comment
One thing is clear: because the regulation now covers all "U.S. persons" and the definition of a "transaction" has been made much broader than a "funds transfer," the reporting requirement now applies to much more than just financial institutions processing funds transfers. On its face, the reporting requirement might apply to any U.S. person who is merely approached about essentially any proposed transaction and that rejects the proposal for sanctions reasons.
The new rule has potentially major implications. U.S. companies may now be in a position where they have to decide in every circumstance where they reject a business opportunity or other transaction due to sanctions whether such a rejection is a reportable "rejection" under §501.604. Failure to report could constitute a violation of the relevant OFAC sanctions program, opening U.S. persons up to civil and criminal penalties for not meeting the reporting requirements.
OFAC estimates that it currently receives about 32,000 reports a year under its overall reporting requirements. The expansion of the rejected transaction reporting requirement could significantly increase that number.
The agency is requesting comments on, among other topics, "[w]hether this collection of information is necessary for the proper performance of the functions of the agency, including whether the information has practical utility[.]" U.S. companies that engage in a significant amount of international trade should consider how the expanded reporting requirement may impact their business and whether this impact should be conveyed to OFAC. The agency is accepting comments on this issue until July 22, 2019.
© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.