Companies Hoping To Tap Into US Capital Markets Must Comply With Trade Sanctions
By Samuel R. Kwon and Keith Martin
Foreign companies may be unable to raise debt or equity in the US capital markets if they have violated US trade sanctions against third countries.
The United States imposes trade embargoes against 11 countries. The 11 are
- Burma (Myanmar)
- North Korea
- Yugoslavia (including Serbian-held regions of
- Bosnia and Herzogovina)
Trade embargoes against India and Pakistan for nuclear testing have been suspended for five years. (The list of countries that are subject to US sanctions expands significantly if one includes countries subject to tax sanctions — like Arab nations that boycott Israel — and countries — like the Czech Republic, Poland and China — with whom buying, selling or merely acting as a broker for sales of arms, nuclear technology, or other goods specifically designed for military uses is prohibited.)
This past spring, PetroChina attempted to raise capital by selling shares in the US market. Its parent — the state-owned China National Petroleum Company — owns 40% of Greater Nile, a state-owned oil company in Sudan. Sudan is subject to US sanctions for supporting international terrorism. All “financial transactions” with government entities in the Sudan are prohibited, and US persons are barred from facilitating exports from Sudan or imports to Sudan from any country. Amidst public outcry and Congressional pressure, dozens of US pension funds declared publicly they would not buy shares, and the offering raised approximately $3 billion rather than the $10 billion initially expected.
In 1997, Gazprom — the Russian gas company — proposed a $1 billion convertible bond offering in the US. At the time, Gazprom owned a 30% interest in a project called South Pars aimed at developing a natural gas field owned by Iran and Qatar, two countries under US sanctions. The Senate Banking Committee indicated that both Gazprom and US underwriters would be violating the Iran-Libya Sanctions Act if they went forward with the offering. The offering never took place.
While compliance with US sanctions does not guarantee a successful offering, it is indispensable to it. The following is a list of steps to follow before launching an offering in the US market.
First, check whether the issuer does business with a country against which the US maintains a trade embargo. Also confirm that the issuer has not violated the broader sanctions list by participating in sales of equipment that has military uses.
Not all US sanctions apply to foreign persons. Most sanctions are “territorial” and these generally prohibit only those “persons subject to the jurisdiction of the United States” from engaging in certain activities. A person subject to US jurisdiction can be a US citizen, US resident, individual physically inside the US, corporation organized in the US, and any entity “owned or controlled” by a person subject to US jurisdiction. Often the sanctions do not spell out when an entity is subject to US jurisdiction by virtue of being “owned or controlled” by a person subject to US jurisdiction. The office of foreign assets control in the US Treasury explains that “control” could mean legal control (i.e. more than 50% voting power) or de facto control (i.e. controlling interest in fact), to be determined on a case-by-case basis.
As a general rule, a US issuer is always subject to the territorial sanctions while a foreign issuer is not. However, where the foreign issuer is majority-owned by a US company or is in fact controlled by a US company, it may also be subject to the sanctions.
An increasing number of sanctions are “extraterritorial.” These sanctions apply to anyone who engages in prohibited activities. For instance, the Iran-Libya Sanctions Act imposes sanctions on anyone — foreign or domestic — who makes a substantial investment toward the development of Iranian oil fields. These sanctions penalize a company even if it is its parent, subsidiary or affiliate that engaged in the prohibited conduct.
If the issuer is violating a sanction, the penalties imposed may prevent the issuer from raising debt or equity in the US capital markets. This issue must be looked at from the perspective of both the issuer and the potential US investor.
From the perspective of an issuer, no current sanction expressly prohibits a violating company from raising capital in the US capital markets as an issuer. The US Securities and Exchange Commission has no official position on this question, though it is working towards “greater disclosure” of the use of proceeds from any US offering.
From the perspective of a potential US investor, the answer is not so clear. When a US investor purchases debt or equity in an issuer owned by, or transacting business with, a country under US sanctions, there is a possibility that such US investor may be “transacting” business with the country under the sanction. Consequently, such investor may itself violate the applicable US sanction and face the corresponding civil and criminal penalties.
Under certain sanctions enacted by Congress, US investors are explicitly prohibited from participating in certain offerings. For instance, the Iran-Libya Sanctions Act prohibits US financial institutions from making loans or credits totaling more than $10 million in any 12-month period to develop Iranian oil fields. This effectively prohibited major US investors from purchasing Gazprom’s bonds and the offering never materialized.
Two possible ways to structure around sanctions problems and still do a US offering are as follows.
One is to create an issuer legally separate from the entity that violated the sanction. Such an issuer can tap into the US capital-markets so long as the issuer itself is not “owned or controlled” by the entity that violated the sanction. This reduces the possibility that the investors in the offering may be deemed to violate the sanctions themselves merely by purchasing the debt or equity instruments of the issuer.
Another idea is to put into place mechanisms to assure investors that the issuer will not violate sanctions in the future either directly or through an affiliate. One way to achieve this is to limit the business of the issuer. For instance, the China National Petroleum Company, which has extensive overseas activities in Sudan and Iraq, limited the scope of PetroChina’s business to the domestic operations in China. Hence, it sought to reassure investors in PetroChina that invested capital could not find its way into Sudan or Iraq. PetroChina also committed that the proceeds of the offering would fund its capital expenditures and investments in China and that any proceeds that made their way directly to China National Petroleum Company would be used solely to repay borrowings and funding employee training programs. Finally, putting into place an audit mechanism to monitor the actual use of proceeds brings greater transparency to the investors and assurance that they are not unwittingly violating US sanctions.