OFAC Extends Reach Over Securities Held by Russia’s National Settlement Depository

OFAC’s new FAQ 1097, issued October 10, warns US investors of the need to block securities held at Russia’s National Settlement Depository (NSD), even if the securities or the issuer is not sanctioned. Even if the security is transferred to local registrars from NSD because of Russian law requirements, OFAC directs US persons to continue treating those securities as blocked. By taking this position, OFAC appears to be expressing the view that NSD, which acted only as a custodian (or central securities depository (CSD)) of these securities, holds an “interest” in those securities.

On June 12, 2024, NSD was added to the US Department of the Treasury Office of Foreign Assets Control’s (OFAC’s) Specially Designated Nationals (SDN) and Blocked Persons List, along with the Moscow Exchange (MOEX) and National Clearing Center (NCC), for operating or having operated in the financial services sector of the Russian Federation economy. As a result of these sanctions, all property and interests in property of NSD, MOEX, and NCC that are in the United States, that come within the United States, or that are or hereafter come within the possession or control of a US person, are blocked. [1]

On the same day, OFAC issued General License (GL) 99 and GL 100 authorizing certain dealings and transactions involving NSD until October 12, 2024. Most relevant, General License 100 (which was reissued as 100A) authorized, until its expiration on October 12, all transactions prohibited by EO 14024 that were ordinarily incident and necessary to the divestment of debt or equity to a non-US person, so long as the recipient is not itself subject to blocking sanctions.

Thus, US persons could, through October 12, take the necessary steps to divest Russian securities held by NSD as custodian, and could involve one or more of NSD, NCC, or MOEX, as long as those entities were acting solely as a securities, trade, or settlement depository, central counterparty or clearing house, or public trading market.

Less than two days before the expiration of GL 100A, OFAC issued Frequently Asked Question (FAQ) 1197 in relation to securities held at NSD, in part prompted by Russia’s issuance of Presidential Decree No. 840. [2] That FAQ states that “following the expiration of GLs 99A and 100A, any securities in the possession or control of US persons that are held at NSD should be treated as blocked, and dividends or other income received via NSD should be treated as blocked”. This applies regardless of whether the issuer is sanctioned, meaning shares of unsanctioned issuers are required to be treated as blocked by the US person owner solely because they were held through NSD.

FAQ 1197 also “takes note” of Russia’s Presidential Decree No. 840 that requires the transfer of the custody of certain securities (namely, shares issued by Russian joint-stock companies) held by US persons (along with the other “unfriendly” jurisdictions) from NSD to local Russian registrars. OFAC warns that such transfers “may be considered null and void.” In other words, even where NSD is no longer the custodian, OFAC’s position is that because the purpose of those transfers is to evade US sanctions against NSD, NSD’s “interest” in the securities remains.

This FAQ represents a new battlement for OFAC with respect to the sanctions against Russia: (1) that custodians sanctioned under EO 14024 are deemed to have an interest in securities they hold; and (2) that the divestment of that interest is not permissible (or valid) without OFAC authorization where those securities are held by a US person. The first runs counter to the position under Russian law, which does not afford any custodian including CSD an interest in the securities it holds in its capacity as custodian.

Moreover, with regard to the divestment, typically, where a sanctioned party divests its interest in a blocked entity outside US jurisdiction (and thus does not require OFAC authorization), the entity is considered unblocked where it has not itself been designated to the SDN List. [3]

In new FAQ 1197, however, OFAC seems to suggest that, as a matter of US law, the share transfers from NSD to the local registrars are not valid because they are unlicensed and occur within US jurisdiction by virtue of the securities being owned by a US person. While US ownership typically creates US jurisdiction in the context of the blocking requirements, OFAC’s decision to take this position, where the US investor has no role in selecting the CSD and has no ability to stop its securities from being moved to a local registrar, immobilizes securities held by US persons.

Applying the interpretations contained in FAQ 1197 to other contexts presents another question: what is OFAC’s position if the securities were not subject to the new investment prohibition and thus, could be legally purchased by a US person, but were transferred to a local registrar from NSD owned by a non-US person? Will OFAC also consider those blocked? Normally, provided the new registrar is not sanctioned, the shares would not be sanctioned unless the issuer itself was sanctioned.

Another critical question that arises relates to the shares on free float. Such shares are often held by NSD as the CSD. FAQ 1197 may suggest that the percentage of shares held at NSD should be added to the calculus done for purposes of OFAC’s 50% Rule, regardless of the fact that Russian law stipulates that NSD does not own or have an interest in securities it holds as custodian.

By way of example, if an entity is owned 36% by an SDN, and 15% of the shares are on free float held by NSD, does FAQ 1197 now mandate that the entity would be sanctioned regardless of whether the owners of those shares in free float themselves are sanctioned?

Ultimately, while FAQ 1197 provides US persons practical advice on their blocking and reporting requirements for their Russian positions held at NSD, the guidance demonstrates an intention by OFAC to expand what constitutes having an “interest” in securities. OFAC likely will be issuing further clarifications to this FAQ as parties struggle with the additional questions its FAQ has created.