Blocked Transactions: What Banks and Businesses Need to Know About OFAC Compliance

Under the federal Bank Secrecy Act (BSA) and the regulations enforced by the Office of Foreign Assets Control (OFAC), financial institutions and businesses have a legal obligation to avoid processing transactions that involve certain foreign entities and individuals. “Blocking” these transactions is a critical component of OFAC compliance, and banks and businesses must report their blocked transactions to OFAC as well.

The obligation to block transactions (and the attendant obligation to report blocked transactions) applies when one or both parties to a transaction have been labeled as Specially Designated Nationals. As OFAC explains:

“As part of its enforcement efforts, OFAC publishes a list of individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific. Collectively, such individuals and companies are called ‘Specially Designated Nationals’ or ‘SDNs.’ Their assets are blocked and U.S. persons are generally prohibited from dealing with them.”

While banks and businesses can search OFAC’s sanctions lists to determine if a party has been labeled as a Specially Designated National, identifying SDNs and having procedures and protocols in place to block transactions involving SDNs should be part of a structured and systematic approach to overall OFAC compliance.

Blocked Transactions: OFAC’s Guidance for Banks and Businesses Dealing with SDNs

As with all aspects of OFAC compliance, it is up to banks and businesses to ensure that they are doing what is required. Banks and businesses must work closely with their legal counsel to ensure that they have the necessary policies, procedures, and protocols in place, and they must internally monitor, audit, and enforce compliance on an ongoing basis. While OFAC provides a limited amount of guidance through resources such as its FAQs and A Framework for OFAC Compliance Commitments, it also makes clear that these resources are intended to be illustrative rather than exhaustive.

Determining what is necessary with regard to blocking transactions (and reporting blocked transactions) requires an in-depth understanding of the governing laws and regulations. While OFAC has published hundreds of FAQs, even these don’t come close to addressing all possible scenarios. Banks and businesses that deal with foreign parties need to be confident in their OFAC compliance programs, and they need to be able to rely on their systems and internal protocols to flag and address suspect transactions before they lead to compliance failures.

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An Introduction to OFAC Blocked Transaction Compliance

With all of this in mind, here is an overview of the fundamentals of managing OFAC blocked transaction compliance:

When Does a Transaction Need to Be Blocked for Purposes of OFAC Compliance?

In general, a transaction must be blocked for purposes of OFAC compliance when one or both parties is an SDN (or a related party) and the transaction would involve the transfer of blocked assets. As noted in the block quote above, SDNs’ assets are generally blocked, which means that banks and businesses in the U.S. must generally block SDNs’ requested transactions as well.

When determining whether a party is related to an SDN, OFAC’s 50 Percent Rule applies. This rule provides 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.”

However, there are some exceptions. For example, an asset freeze may be necessary in some cases, and some transactions may need to be “rejected” rather than “blocked.” Banks and businesses must reflect the specific nature of their compliance efforts in their reports to OFAC, and improperly classifying a bank’s or business’s actions (even if their actions were appropriate) can potentially lead to OFAC scrutiny.

OFAC also distinguishes between “payment instructions” (which may require blocking) and “inquiries” (which do not). As OFAC explains in FAQ #53: “If . . . 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. The same logic applies to cases where the transaction would be required to be rejected under OFAC regulations. There is not technically a ‘reject’ item until the bank receives instructions from its customer to debit its account and send the funds.”

How Do Banks and Businesses Block Transactions for Purposes of OFAC Compliance?

The process of blocking a transaction for purposes of OFAC compliance depends on the nature of the assets involved. For funds transfers, OFAC advises that, “Once it has been determined that funds need to be blocked, they must be placed into an interest-bearing account on your books from which only OFAC-authorized debits may be made.” OFAC’s FAQs indicate that entities may either establish separate accounts for individual blocked transactions or place funds from multiple blocked transactions into a single segregated account, “so long as there is an audit trail which will allow specific funds to be unblocked with interest at any point in the future.”

Regarding cryptocurrency transactions, OFAC explains in FAQ #646 that upon identifying cryptocurrency as blocked, banks and businesses “must deny all parties access to that virtual currency, ensure that they comply with OFAC regulations related to the holding and reporting of blocked assets, and implement controls that align with a risk-based approach.” OFAC also clarifies that U.S. entities do not need to convert blocked cryptocurrency into traditional fiat currency or hold it in an interest-bearing account.

What is the Difference Between a Blocked Transaction and a Rejected Transaction?

Banks and businesses must “reject” transactions that violate OFAC’s sanctions programs when there are no assets that can be blocked. It provides the following example in 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, an[] 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), unless authorized by OFAC or exempt from regulation.”

Rejected transactions are also subject to reporting; and, as noted above, banks and businesses must accurately characterize transactions as either “blocked” or “rejected” in order to meet their compliance obligations.

What Are the OFAC Blocked Transaction Reporting Requirements?

Under OFAC’s regulations, U.S. entities that block (and reject) transactions pursuant to OFAC’s sanctions programs have two reporting obligations. First, they must report all blocked (and rejected) transactions within 10 business days of the date of the action. Second, they must file a report of blocked property annually by September 30. OFAC provides an optional reporting form for individual transactions and a standardized form for annual reports. OFAC has also published additional information on annual blocked transaction reporting in its Guidance on Filing the Annual Report of Blocked Property.

Can (and Should) U.S. Entities Notify Customers that Their Transactions Have Been Blocked or Rejected?

With regard to notifying customers that their transactions have been blocked or rejected, OFAC advises that, “[a]n institution may notify its customer that it has blocked funds in accordance with OFAC’s instructions.” Thus, banks and businesses have discretion to determine whether to inform customers that their transactions are prohibited under OFAC sanctions.

Once a U.S. entity has blocked a transaction, the customer may apply for a license to obtain the release of the assets involved. If OFAC authorizes the release of blocked assets, the U.S. entity may then release the assets in accordance with OFAC’s license.

What are the Consequences of Failing to Block a Transaction Prohibited Under an OFAC Sanctions Program?

The consequences of failing to block a transaction prohibited under an OFAC sanctions program can be significant. Banks and businesses that fail to maintain effective OFAC compliance programs are subject to examinations and enforcement, and enforcement actions can lead to substantial fines and other penalties. When transactions have national security implications or impair the federal government’s foreign policy objectives, failure to block (or reject) and report them can have additional consequences as well.

As a result, all U.S. entities that are subject to OFAC’s oversight need to prioritize compliance. This means not only implementing an effective OFAC compliance program, but also actively managing compliance on an ongoing basis. There are several other aspects to OFAC compliance as well, and maintaining a comprehensive OFAC compliance program is essential for effective risk management.

Speak with an OFAC Compliance Lawyer or Consultant at Oberheiden P.C.

The OFAC compliance lawyers and consultants at Oberheiden P.C. work with banks and businesses of all sizes to help them establish, maintain, and document OFAC compliance. This includes all aspects of blocked transaction compliance. To speak with one of our senior lawyers or consultants in confidence, please call 888-680-1745 or request a consultation online today.