Blocked Transactions: What Financial Institutions Need to Know About OFAC Compliance - Federal Lawyer
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Blocked Transactions: What Financial Institutions Need to Know About OFAC Compliance

Bribery And Corruption Concept, Bribe In The Form Of Dollar Bill

Financial institutions (including banks and other businesses that process financial transactions) have an obligation to avoid processing transactions that violate Office of Foreign Assets Control (OFAC) sanctions programs. This means “blocking” prohibited transactions in most cases—although sometimes financial institutions must “reject” transactions instead.

Blocking and rejecting prohibited transactions (and reporting these actions to OFAC) are key components of overall OFAC compliance. Financial institutions must have policies, procedures, protocols, and systems in place to identify blocked parties and assets, and they must take appropriate action to avoid processing transactions that have national security, foreign policy, or other pertinent implications.

“Banks and businesses that process transactions involving foreign entities and individuals need to prioritize OFAC compliance. Among other things, this means ensuring that they have the necessary tools to identify prohibited transactions, avoid processing these transactions, and timely report their compliance efforts to OFAC.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

So, what does it take for financial institutions to maintain OFAC blocked transactions compliance in 2023? Here are some key considerations:

1. When a Transaction Needs to Be “Blocked” Under an OFAC Sanctions Program

Generally, financial institutions must block proposed transactions that involve Specially Designated Nationals (SDNs). As OFAC explains, SDNs’ assets “are blocked[,] and U.S. persons are generally prohibited from dealing with them.”

The obligation to block transactions also extends to transactions involving parties that are related to SDNs. When determining whether parties are related, financial institutions must apply OFAC’s 50 Percent Rule. This rule states that, “the property and interests in property of entities directly or indirectly owned 50 percent or more in the aggregate by one or more blocked persons are considered blocked.”

2. When a Transaction Needs to Be “Rejected” Under an OFAC Sanctions Program

In some cases, transactions will need to be “rejected” rather than “blocked.” Rejection of a transaction is required when the transaction is prohibited under an OFAC sanctions program but “there is no blockable interest (i.e., that of a Specially Designated National (SDN) or blocked person or government) in the transaction.” OFAC provides the following example in its FAQ #36:

“[A] U.S. financial institution would have to reject a wire transfer between two third-country companies (non-SDNs) involving an export to a company in Iran that is not otherwise subject to sanctions. Since there is no interest of the blocked person (e.g., the Government of Iran, and Iranian financial institution, or an SDN), there is no blockable interest in the funds. However, the U.S. financial institution cannot process the transaction because that would constitute a prohibited export of services to Iran pursuant to the Iranian Transactions and Sanctions Regulations (ITSR) . . . .”

Whereas blocking a transaction involves placing the funds involved into an interest-bearing account, rejecting a transaction simply involves not processing it and returning any funds received to the originating party. However, similar to blocked transactions, financial institutions must still report all rejected transactions to OFAC.

3. Blocking a Transaction Prohibited By OFAC Sanctions

Blocking a transaction involves more than simply declining to process it. As we just discussed, when a financial institution blocks a transaction prohibited under OFAC sanctions, it must place the SDN’s blocked assets into an interest-bearing account. Blocked funds must earn interest at a commercially reasonable rate. OFAC advises that financial institutions can either establish separate accounts for individual blocked transactions or place blocked assets in one or more “omnibus accounts.”

4. Rejecting a Transaction Prohibited By OFAC Sanctions

Rejecting a transaction is a simpler process than blocking a transaction that involves one or more SDNs. When a transaction is subject to rejection rather than blocking under OFAC sanctions, a financial institution can (and must) decline to process the transaction. Rather than retaining any funds received in an interest-bearing account, the financial institution must return the funds to the originating party—and should do so promptly to avoid any questions as to whether the institution is involved in a prohibited transaction in any capacity.

5. Reporting Blocked and Rejected Transactions to OFAC

As noted above, financial institutions must report both blocked and rejected transactions to OFAC. As OFAC explains in FAQ #49, “31 C.F.R. Parts §§501.603 and 501.604 require blocking and reject reports to be submitted to OFAC within 10 business days of the date of the action.” OFAC provides an optional reporting form that financial institutions can submit via email to the Office’s Sanctions Compliance and Evaluation Division. All reports must be accompanied by a copy of the original transfer instructions for each transaction being reported.

In addition to reporting individual transactions within 10 days, financial institutions must also file an annual report of blocked property by September 30. This report is also submitted to OFAC’s compliance division, and OFAC provides a standardized form and guidance for completing the form in FAQ #50. While use of the standardized form is not mandatory, financial institutions must request approval prior to submitting an annual blocked property report in an alternate format.

6. Disclosing a Blocked or Rejected Transaction to a Customer

OFAC’s FAQ #41 addresses the question of whether financial institutions should inform customers (i.e., SDNs) that their transactions have been blocked or rejected. In its answer, OFAC advises that, “An institution may notify its customer that it has blocked funds in accordance with OFAC’s instructions.”

This means that financial institutions have discretion to decide whether to tell customers that their transactions have been blocked or rejected. Regardless, customers will find out eventually; and, when they do, they have the ability to apply to have their blocked funds released. This application is submitted to OFAC; and, if OFAC approves the release of blocked funds, then the financial institution must release the blocked funds in accordance with OFAC’s instructions.

7. Releasing Customer Assets After Blocking a Transaction Pursuant to OFAC Sanctions

Once a financial institution blocks a transaction, it must hold the blocked funds in an interest-bearing account until it receives approval to release them from OFAC. The process of applying for the release of blocked funds can be a time-intensive process, and SDNs and other parties can encounter various issues when seeking the release of blocked funds.

When holding blocked funds, the financial institution’s job is largely just to wait. If OFAC determines that a release of funds is warranted, 31 C.F.R. Part 501.806(f) provides that “the Office of Foreign Assets Control will direct the financial institution to return the funds to the appropriate party.”

8. Dealing with Uncertainty Regarding the Implications of OFAC’s Sanctions Programs

Even with the extensive regulations governing OFAC’s sanctions programs and the guidance that OFAC makes publicly available online, determining financial institutions’ obligations isn’t always (or even often) easy. Various issues can arise; and, while financial institutions must be careful to maintain strict OFAC compliance, they also have a valid business interest in ensuring that they do not block or reject customers’ transactions unnecessarily.

For example, one issue OFAC addresses in its FAQs is the distinction between an “inquiry” and a “payment instruction.” While inquiries do not trigger blocking or rejection obligations, payment instructions might. OFAC instructs that in the case of a wire transfer a financial institution may come into possession of blocked assets upon receiving “concrete instructions” to send the funds involved. Conversely, OFAC explains that “[i]f, on the other hand, a customer simply asks ‘Can I send money to Cuba?’ there is no blockable interest in the inquiry and the bank can answer the question or direct the customer to OFAC.”

9. Consequences of Failing to Block (or Reject) Transactions Prohibited Under OFAC Sanctions

For U.S. financial institutions, the consequences of failing to block (or reject) a transaction prohibited under an OFAC sanctions program can be substantial. Violations of OFAC sanctions can lead to enforcement action with the potential for millions of dollars (and in some cases even billions of dollars) in potential civil liability. While OFAC has shown a willingness to settle enforcement actions in most cases, financial institutions must be prepared to show that they took reasonable steps to avoid processing prohibited transactions when facing scrutiny.

10. Implementing an Effective OFAC Sanctions Compliance Program

From blocking and rejecting prohibited transactions to withstanding OFAC scrutiny when necessary, the key for all financial institutions is to implement an effective OFAC sanctions compliance program. There are numerous aspects to OFAC sanctions compliance, and banks and businesses must thoroughly address all pertinent aspects in all aspects of their operations. They must have appropriate policies and procedures in place, and they must utilize sanctions screening software and other appropriate safeguards to ensure that they have the capabilities required to identify SDNs and other sanctions-related concerns.

Appointment of an OFAC Compliance Officer and organization-wide training are key to effective OFAC compliance management as well. Blocking transactions, rejecting transactions, and reporting blocked and reported transactions to OFAC should all be systematic processes that financial institutions execute as a matter of course. Financial institutions should audit their compliance efforts as well, and they should work closely with their counsel to implement updates to their OFAC sanctions compliance programs as necessary.

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