Managers of venture capital and private equity funds – who in general must ensure compliance with sanctions regimes to which they are obligated to comply – need to pay special attention to recently strengthened requirements related to Russia and Belarus. This post answers some common questions about the applicable requirements.
Do private fund managers need to comply with US sanctions regulations?
Fund managers who are subject (or likely subject) to US jurisdiction need to comply with US sanctions regulations. US sanctions against Russia and Belarus apply to US persons, which are defined to include US citizens and permanent resident aliens, persons holding special immigration status (e.g., refugees and aslyees), entities organized under US law, and any person acting within the United States. Whether a fund is subject to US jurisdiction is a complicated issue, but in general, if your fund or fund manager is legally organized in the US, if one or more of the control persons of the fund manager are US persons or located in the US, if the fund manager has an office located in the US, and/or if the fund directly or indirectly has US investors, the fund manager and fund are likely subject to US jurisdiction and should comply with US sanctions regimes.
What do I need to do with respect to the potential that limited partners are directly subject to Russian or Belarusian sanctions?
We recommend undertaking the following three-step process to assess your direct exposure to Russian or Belarusian sanctions issues:
- Check your records to ensure that none of your limited partners are located in the Crimea, Donetsk or Luhansk areas of Ukraine.
- Check your records to ensure that no Russian or Belarusian governmental entities, including sovereign wealth or other state-sponsored entities, are limited partners directly.
- Check your limited partner list against the Office of Foreign Assets Control (OFAC) list of Specially Designated Nationals and Blocked Persons to ensure no persons or entities match your directly subscribed limited partners.
If you identify the potential existence of any of the above types of limited partners, contact your legal counsel immediately for assistance – and refrain from accepting capital contributions from or making distributions to such investors until your legal counsel has discussed the situation with you.
What about the potential that sanctioned parties indirectly hold interests in my direct limited partners?
You are obligated to ensure that none of your direct limited partners are in turn more than 50% owned, directly or indirectly, by persons or entities on the US sanctions lists. Generally, clients we work with will often first determine their comfort level with respect to the potential for indirect issues (i.e., “look-through issues”) with their limited partner base. On one end of the spectrum, a fund that is comprised of all individuals known to be US persons has no look-through issue. On the other end of the spectrum, a large fund raised globally that has numerous institutional limited partners may have a material risk of look-through issues.
Where a fund is concerned about look-through issues, the next step is usually to examine the fund’s subscription materials. In some cases, those materials may contain representations made by entity limited partners at the time of subscription to the effect that none of their capital is attributable to sanctioned parties, together with representations to update the fund manager of any future changes. If you are in this situation, you might determine either to rest on these representations or to disseminate a reminder to your applicable limited partners of their attendant obligations. If the fund’s subscription materials do not rise to the above level or if there are additional concerns, the fund manager may wish to obtain current, proactive representations from applicable limited partners to have more certainty that there are not indirect issues with the fund’s limited partner base. The fund’s counsel should assist to develop the appropriate questionnaire depending on the exact circumstances.
Do I really need to worry about any of this? What are the potential consequences of failing to comply?
The potential consequences are serious. Violations are enforced on a “strict liability” basis – meaning if you have sanctioned persons or entities in your limited partner base (directly or indirectly with reference to the above 50% standard) you are in violation – there is no “intent” element. Further, failure to timely identify sanctions issues may lead to a continuing series of violations. OFAC, for its part, treats violations as a serious threat to national security and foreign relations. As a result, offenders face very significant monetary fines. In addition, criminal penalties, including prison time, can be pursued for willful (i.e., knowing and intentional) violations.
What about my portfolio companies?
Where a portfolio company is not a controlled entity (as typical for most venture capital fund managers), in general there is not a legal requirement to ensure compliance, as such legal requirement falls to the portfolio company and its management. However, as portfolio companies can experience significant monetary fines for transacting with sanctioned parties, and as reputational issues may accrue even to such companies’ investors, it is prudent to ensure that each of your portfolio companies is taking steps to ensure sanctions compliance. In addition, you may have agreed in a side letter with one or more of your limited partners to monitor compliance of your portfolio companies. If you are aware of potential sanctions violations by a portfolio company, or if you make control investments, contact the fund’s legal counsel immediately for further assistance.
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