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State and Local Divestment Measures: A Growing U.S. Trade Compliance Concern

Friday, March 8, 2013
Alexandre Lamy and Maria van Wagenberg, Baker & McKenzie

In recent years, a growing number of U.S. state and local governments have adopted divestment measures targeting companies doing business or investing in Iran and Sudan, among other countries. These divestment measures typically prohibit governmental entities from investing in or contracting with certain listed companies. Because federal sanctions already prohibit U.S. companies from engaging in virtually all transactions involving Iran or Sudan, the primary targets of such measures have been non-U.S. companies. The consequences of such divestment actions for non-U.S. companies include reputational risks and subsequent divestment actions, making it important for non-U.S. companies to remain vigilant about divestment-related inquiries into their sanctioned country activities and subsequent divestment listings.

I. Potential Consequences of Divestment
By a State or Locality

The direct financial impact of a single state/local divestment action may appear quite limited, especially for a company whose shares are widely held or traded in financial markets. The damage can be multiplied, however, by potential reputational risks and information sharing among U.S. state/local governments and third-party research firms, which in turn can lead to other state/local divestment actions. The potential reputational risks can increase to the extent private pressure groups use information about divestment targets to further encourage companies to end sanctioned country business.

Because of the large variety in state/local divestment programs in terms of the criteria, procedures, and penalties applied, many non-U.S. companies may face difficulty in determining the scope of their divestment exposure and coordinating their responses to different divestment measures. Divestment criteria frequently differ among states/localities and sometimes conflict with or exceed the scope of U.S. federal sanctions. In addition, non-U.S. companies do not always recognize the potential significance of a divestment inquiry or respond in the necessary timeframe, particularly because inquiries sometimes take time to reach the correct legal or compliance personnel.

It is important that companies immediately respond to potential divestment inquiries and attempt to correct divestment listings that may be based on inaccurate or outdated information. In particular, company departments that are likely to receive such inquiries should be instructed to promptly forward correspondence regarding sanctioned country business, whether from state/local government agencies or third-party research firms, to the relevant legal or compliance personnel to ensure the company provides an appropriate response.

II. Authorities for State/Local
Divestment Measures

In general, state/local divestment measures with foreign policy implications must be adopted pursuant to authorizing federal legislation.1 Congress and the President have authorized divestment measures with respect to Sudan under the Sudan Accountability and Divestment Act of 2007, P.L. 110-174 (SADA), and with respect to Iran under the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010, P.L. 111-95 (CISADA). As a threshold matter, it is important to understand that non-U.S. companies may be in compliance with U.S. sanctions (extraterritorial or otherwise) and still be the subject of divestment actions or inquiries.

a. SADA

SADA authorized state/local governments to divest their assets from, or prohibit future investments in, parties (or their successors, subsidiaries, or parents) that do business or invest in power production, mineral extraction, oil-related, or military manufacturing activities in Sudan, as determined by the state/local government based on credible public information. Under this provision, state/local governments are also authorized to ban public contracting and public extensions of credit to such companies.

Under SADA, 90 days notice must be provided to parties potentially subject to a divestment measure adopted by the state or locality after Dec. 31, 2007. SADA prohibits the application of divestment measures adopted pursuant to SADA to parties that demonstrate they do not meet the SADA divestment criteria.

b. CISADA

CISADA authorized state/local governments to divest their assets from, or prohibit their future investments in, parties (or their successors, subsidiaries, parents, or affiliates) that are either (a) companies with investments of $20 million or more in Iran's energy sector or (b) financial institutions that extend credit of $20 million or more for such investments, as determined by the state/local government based on credible public information. Under this provision, state/local governments are also authorized to ban public contracting and public extensions of credit to such companies.

Iran divestment measures enacted after July 1, 2010, must conform to the CISADA criteria described above; however, CISADA also retroactively authorized Iran divestment measures enacted prior to that date, which appears to permit measures with different or broader divestment criteria than those authorized under CISADA. Accordingly, some Iran divestment measures in place prior to July 1, 2010, target a more extensive range of activities than the limited scope of activities enumerated in CISADA.

In addition, CISADA required Iran divestment measures enacted after July 1, 2010, to provide certain procedural protections to parties potentially subject to divestment, including at least 90 days notice and an opportunity for a hearing. After July 1, 2012, all state/local divestment measures enacted pursuant to or retroactively authorized by CISADA must meet, at a minimum, the 90 day notice and hearing requirements.

III. Types of State/Local Divestment Measures
And Implementation Procedures

According to an ongoing survey conducted by the authors, at least 28 states and six localities have adopted divestment measures with respect to Iran. A June 2010 report by the Government Accountability Office indicates that at least 35 states have done so with respect to Sudan.2 The discussion below focuses primarily on Iran divestment measures, although many of the issues also apply in the context of divestment measures targeting Sudan and other countries.

a. Types of Iran Divestment Measures

The most common types of Iran divestment measures prohibit state pension funds from holding or acquiring investments in a specific list of companies determined to have business or investments in Iran. More recently, a growing number of states and localities have banned public contracting with companies determined to do business or invest in Iran.

California has perhaps the broadest array of Iran-related divestment measures, imposing divestment pursuant to three authorities: (1) a state pension fund divestment law, the California Public Divest from Iran Act,3 (2) a public contracting ban, the Iran Contracting Act of 2010,4 and (3) a state insurer divestment law, which is drafted to apply with respect to federally-identified state sponsors of terrorism (i.e., Cuba, Iran, Sudan, and Syria).5 Public contracting bans have also been enacted by Arizona, Florida, Indiana, Maryland, Michigan, New Jersey, and New York.

b. Divestment Criteria

State/local governments apply a wide variety of criteria to determine what activities are subject to divestment. While some states apply criteria substantively similar to those set out in CISADA, other states use criteria that diverge significantly from the federal criteria and/or the criteria used by other states. In general, Iran divestment measures target activities in the military, energy, or governmental sectors of Iran. To take California as an example, the California Public Divest from Iran Act requires state retirement funds to divest from companies that (a) are subject to sanctions under the Iran Sanctions Act for having investments of $20 million or more in Iran's energy sector, (b) invest or do business in Iran's nuclear or defense sectors, or (c) have demonstrated complicity with an Iranian organization labeled as a terrorist organization by the United States.

Other divestment measures target companies doing business in sanctioned countries other than Iran or Sudan. For example, Indiana's divestment law requires state retirement systems to divest from companies that provide military equipment to state sponsors of terrorism (including Cuba and Syria) or that have a certain level of oil, mineral, or power-related business involving such countries.6 There is no federal law authorizing divestment against companies engaged in business activities in Cuba or Syria, however. Nonetheless, there do not appear to have been any legal challenges to Indiana's divestment law.

Florida recently attracted attention when it amended its public contracting ban to extend to companies with any business in Cuba or Syria.7 In a rare challenge to the scope of a state/local divestment law, a federal district court granted a preliminary injunction to enjoin enforcement of the law on constitutional grounds. Florida is currently appealing this injunction.

c. Divestment Procedures

In deciding which companies to subject to divestment, states and localities rely on information collected by other sources, including federal agencies, non-governmental organizations, or third-party research firms. Third-party research firms appear to obtain their lists, in significant part, from publicly available information but may confirm their research through direct communications with targeted companies. In addition, some states “borrow” the divestment lists of other states. For example, Nevada, Utah, and Washington rely on the divestment lists compiled by Florida.8 Accordingly, companies concerned about potential divestment actions should remain particularly vigilant about potential listings under Florida's divestment law.

Most states publish a list of companies subject to divestment action. A few also list all companies meeting the state's divestment criteria, regardless of whether the state currently has holdings or contracts with those companies. Several states (including Florida and California) maintain both a list of “prohibited” companies, in which state investments are banned, and a list of “monitored”companies, which are identified for continued scrutiny usually because of past activities in sanctioned countries or because the state is still determining the company's status. A company subject to “monitoring”may receive divestment inquiries from other states as a result, regardless of whether it has been subject to divestment by the “monitoring”state.

d. Notice and Hearing Requirements

For Iran divestment measures, most states and localities appear to comply with CISADA's notice and hearing requirements where applicable. Notice is typically provided through a letter sent to a company potentially subject to divestment action. Such notices ask companies to respond within a specified time period either to contest a potential divestment action or to describe substantial actions taken to wind down Iran-related business or investments. In some cases, notice is provided through a third-party research firm. Some states, among them Indiana, publish their divestment-related correspondence with companies online.

To request delisting from a divestment list, companies must typically submit a letter to a state agency explaining why the factual basis for potential divestment is inaccurate or why the company does not otherwise meet the specific criteria for divestment. Some states instruct companies to submit delisting requests to the third-party research firm that originally identified the company and to negotiate delisting directly with that firm. In our experience, most states and localities are receptive to delisting requests submitted by companies that have terminated sanctioned country business since being subjected to divestment.

IV. Conclusion

Given the broad political support for sanctions at different levels of the U.S. government, we are likely to see growing numbers of state/local divestment measures adopted pursuant to federal authorities. Non-U.S. companies with past or current business activities in sanctioned countries and with good arguments against potential divestment actions must remain vigilant about the various types of state/local divestment efforts.

More practically, such non-U.S. companies should ensure that divestment inquiries from state/local governments or third-party research firms are reviewed and addressed promptly and appropriately, regardless of where the inquiries are received within the company. Prompt, effective, and persuasive responses to divestment inquiries can mitigate in many ways the potential risk of a company being subject to divestment.

Alexandre Lamy and Maria van Wagenberg are both associates in Baker & McKenzie's International Trade Compliance and Customs Practice Group in Washington, D.C. Mr. Lamy and Ms. van Wagenberg advise clients on a variety of export controls, sanctions, anti-corruption, and corporate compliance issues. Mr. Lamy serves on the steering group for the ABA Section of International Law's Export Controls & Economic Sanctions Committee.

©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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