June 22, 2022 – According to White House statements, “The United States, together with the G7 and the European Union, will continue to impose serious and immediate economic costs on the Putin regime for its atrocities in Ukraine, including in Bucha”. As part of this effort, in an April 6, 2022 White House statement, “devastating economic measures to ban new investment in Russia and impose the toughest financial sanctions on Russia’s largest bank and many of his most critical state-owned enterprises and on Russian government officials and their family members”.
This article examines the penalties program and the potential implications of penalties for insurance coverage.
On May 2, 2019, the Office of Foreign Assets Control (OFAC), a unit of the U.S. Treasury Department responsible for enforcing U.S. economic sanctions programs, released “A Framework for OFAC Compliance Commitments” to provide organizations , subject to jurisdiction, with guidance from OFAC regarding the essential elements of a sanctions compliance program, including how OFAC can assess apparent violations and ultimately resolve investigations resulting in settlements.
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This framework continues to be applied to the new sanctions program related to the Russian invasion of Ukraine. The rules governing OFAC’s regimes and compliance will change frequently as the government gains more experience with each program and seeks to increase pressure on Russia. For example, on March 11, 2022, President Joe Biden extended financial and trade sanctions against Russia just three days after increasing sanctions in place since March 6, 2014.
Pursuant to the International Emergency Economic Powers Act, 50 USC § 1701 et seq. (IEEPA), violations of OFAC sanctions against Russia are subject to criminal and civil penalties. When someone “willfully” breaks the rules, the U.S. Department of Justice can incur criminal penalties of up to $1 million per violation and, in the case of individuals, up to 20 years in prison. .
In terms of civil penalties, violations are “strict liability” torts. This means individuals and companies can potentially be held liable and subject to significant penalties, even if they were unaware that their activities were not ostensibly innocent.
The calculation of the penalty varies according to the type of offense and the year committed. Depending on various factors, the basic civil monetary penalty for a “flagrant” violation may be equal to the greater of a fixed amount per violation or twice the amount of the underlying transaction. If OFAC determines that a violation is “not flagrant”, then the maximum base civil monetary penalty for the violation is calculated based on the dollar value of the transaction under a significantly reduced penalty schedule, which caps any penalty. for violation to a maximum amount per violation. .
As a recent example, on April 1, 2022, OFAC announced a $78,750 settlement with S&P Global, Inc. (S&P Global), a New York-based company that provides business information and financial analysis. S&P Global has agreed to settle its potential civil liability for apparent violations of the Ukraine Sanctions Regulations, 31 CFR part 589, specifically Directive 2 issued pursuant to Executive Order 13662 dated March 24, 2014, “Freezing of property of other persons contributing to the situation in Ukraine” (EO 13662). This sanctions directive predates the current invasion and relates to the earlier “situation in Ukraine”.
The apparent violations occurred between August 2016 and October 2017, when S&P Global and a company it acquired reissued and redated several invoices to continue extending credit to JSC Rosneft (Rosneft), a Russian oil company owned by the State, in violation of the debt and equity restrictions set out in the 2014 Executive Order.
After reissuing and re-dating four invoices to extend the original payment dates, S&P Global accepted overdue payments totaling $82,500 from Rosneft. OFAC determined that S&P Global did not “voluntarily disclose the apparent violations” and that the “apparent violations constitute a non-flagrant case.”
According to OFAC, the statutory maximum civil monetary penalty applicable to the S&P Global transaction was $1,246,248. The basic civil monetary penalty applicable to the S&P Global transaction was based on the expected amount of $175,000. The final settlement amount of $78,750 reflected “OFAC’s review of general factors within the framework of the enforcement guidelines.”
When evaluating potential insurance coverage for OFAC penalties, it is initially important to note that policy terms vary and enforcement of those terms – particularly with respect to fines and penalties – differs significantly from jurisdiction to jurisdiction.
The November 23, 2021 decision in JP Morgan Securities Inc. v. Vigilant Insurance Co., of the New York Court of Appeals focused specifically on coverage for fines and penalties imposed, but not on penalties imposed by OFAC. Following an investigation by the Securities and Exchange Commission, the insured’s predecessor (Bear Stearns) reached a settlement with the SEC in 2006, agreeing to pay a “disstitution” payment of $160 million and a payment of 90 million dollars for “civil penalties”.
According to the court, $140 million of the refund payment allegedly reflected an estimate of profits made by Bear Stearns customers as a result of the illegal activity. Following its settlement with the SEC, Bear Stearns requested coverage from the insurer for the $140 million portion of the payment.
Insurer asked to consider whether a $140 million ‘disstitution’ payment made by the insured’s predecessor (Bear Stearns) to the SEC for alleged illegal business practices was a ‘penalty imposed by law’ and therefore was not covered by the definition of “Loss” contained in the policy.
The Court of Appeals ruled under New York law that “penalties have always been distinguished from compensatory remedies, damages, and payments otherwise measured in terms of the harm caused by wrongdoing.” Thus, at the time when the parties contracted, a reasonable insured would also have understood the term “penalty” to designate non-compensatory and purely punitive pecuniary sanctions. More specifically, the Court determined that “a penalty is distinct from a compensatory remedy and that a penalty is not measured by the losses caused by the wrongdoing”.
By analyzing Bear Stearns’ communications with the SEC during settlement negotiations, as well as testimonial and documentary evidence, the Court found that Bear Stearns demonstrated that the $140 million restitution payment was subject to cover. The Court explained that “neither the label assigned to the payment by the SEC and Bear Stearns, nor the mere fact that injured parties may ultimately receive the funds, is determinative.
But, in determining whether Bear Stearns’ “return” of customer earnings was a “penalty” within the meaning of the insurance policies, these factors must be weighed together with the fact that the payment was indeed a measure of the investors’ losses. . To the extent that it was derived from estimates of ill-gotten gains and harm arising from abusive business practices and was intended – at least in part – to compensate those harmed by the wrongdoings allegedly facilitated by Bear Stearns, the restitution payment of $140 million could not have been properly interpreted as a “penalty” in determining coverage.
In summary, assessing the coverage of an OFAC-imposed sanction will give rise to a multitude of coverage issues depending on the policy potentially involved, the applicable jurisdiction, the type of violation and the sanction imposed. The parties should consult the legal counsel for the insurance coverage if such problems arise.
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