by Dale Stackhouse et al.
Ice Miller LLP is an IMA Member
There are many opportunities for U.S. companies to grow their business by focusing on exports or on expanding their supply chain globally to access inputs to their U.S. based operations. These opportunities come with some particular and often difficult to anticipate risks when dealing with individuals or countries the United States government has concluded pose a national security threat or concern. Unfortunately, many of these risky relationships can hide in plain sight and often involve countries that, unlike North Korea or Iran, are not obvious areas of national security concern. When a U.S. company ends up dealing with the wrong third party – whether as a customer, supplier or distributor – the consequences can range from civil penalties to criminal prosecutions.
Since 2001 in particular, the United States Treasury Department has effectively weaponized the U.S. dollar in the global economy, turning it against the regimes in Iran, Venezuela, and North Korea, as well as against narco-traffickers, terrorists, and human rights violators. The collateral damage of this enhanced enforcement regime is often to a small- or medium-sized U.S. business that was inadvertently exporting services or goods to the wrong international customers or purchasing supplies from the wrong foreign country. Suddenly, what initially appeared to the company to be an innocuous, run-of-the-mill business transaction can balloon into a sanctions violations case resulting in millions of dollars in fines and penalties, bad press, and intense scrutiny by government regulators.
One reason why so many companies are penalized for violating U.S. sanctions is that the regulations enforce an almost strict liability level of conduct. In other words, intent to violate the law is not required for the government to file a complaint. And, if there is some degree of knowledge on the part of the company or its employees sufficient to approach “willful blindness,” criminal penalties may also enter the picture. What you don’t know can and will hurt you in this area.
Since 2010, the Office of Foreign Assets Control (OFAC), which oversees U.S. trade embargoes, has greatly expanded the number of sanctions targets to include more countries, companies, and individuals and has also made the sanctions regimes far more complex. Traditionally, sanctions worked by “blocking” individuals or companies by making them “Specially Designated Nationals,” who were placed on the “SDN list.” A U.S. person, which is broadly defined to include any U.S. citizen, permanent resident alien, or entity organized under the laws of the U.S., and anyone in the U.S., would then be prohibited from any activity related to the property of an SDN, including bank accounts, real estate, or even contingent contracts for a future deal. Companies often only discover they are dealing with the wrong people when they find that their bank has blocked an incoming payment or frozen an account, which is then reported to the Treasury Department and may result in an investigation by OFAC or, in some cases, the Department of Justice.
With the imposition of extraterritorial sanctions against Iran in 2010 (which were suspended and then “snapped back” in 2017) and with sanctions in 2014 against Russia/Ukraine and Venezuela, OFAC instituted far more complex sanctions focused on financial transactions, applying different prohibitions on transactions involving financing of debt or equity investments, or in the case of Russia, proscribing support for energy and defense sector activities. OFAC has also aggressively used “secondary sanctions” with extraterritorial effects against non-US companies, primarily banks. In turn, these companies can complicate many transactions by requiring higher levels of “know your customer” diligence, which a U.S.-based company will need to navigate carefully, because OFAC can and does enforce regulations against evasion and facilitation of sanctions violations.
Equally frustrating for many companies is that sanctions can turn a transaction that was perfectly legal one day into a prohibited one the next. Sometimes there may be a brief “wind-down” period to allow U.S. persons to extricate themselves from a relationship with an SDN, but these often come with punishing losses as investments lose their value. And in other cases, the sanctions can kick in overnight – a tough position for a company that has no contractual exit provisions to mitigate losses or non-payment.
To protect against an inadvertent mistake that can turn into a costly investigation and embarrassing public settlement with the Treasury Department, companies should implement a robust system for vetting customers, suppliers, distributors, and any other third-parties doing business internationally (in some cases you should also vet employees for foreign business entities). OFAC risks can slip in through many side doors that may not be obvious or anticipated – for example, a U.S. company was recently penalized for putting up employees in a hotel located in China. Amazingly, the sanctions program that was violated was one of the oldest, the Cuban Assets Control Regulation, because the hotel was owned by a Cuban state-owned company.
Small- and medium-sized businesses (“SMBs”) need to be especially mindful of their global supply chains and their global customer bases. Often, Iranian or North Korean companies operating as fronts will aim their sanctions-busting efforts at SMBs in cities and locales that may not have large export-focused industries in order to avoid dealing with companies already protecting themselves with compliance programs. Some examples of recent enforcement actions that demonstrate the reach of OFAC include:
- January 2019, OFAC fined California-based e.l.f. Cosmetics nearly $1 million after the company disclosed that one of its Chinese suppliers of false eyelash kits sourced some of the components of the kits from North Korea. OFAC determined that e.l.f. violated U.S. sanctions by importing 156 shipments of false eyelash kits that contained the North Korean materials.
- Illinois Tool Works (“ITW”) was recently fined by OFAC after one of its foreign subsidiaries – AppliChem – sold chemicals to Cuba. From 2012-2016, AppliChem acknowledged that it had 304 separate violations and shipped $3.4 million of products to Cuba. AppliChem engaged in the violations after being specifically told by ITW officials that, as a subsidiary of a U.S. corporation, it could not continue doing business in Cuba. In early 2019, ITW settled the case with the U.S. government – agreeing that AppliChem would pay $5.5 million in fines to OFAC.
- A Connecticut-based materials company agreed this year to pay approximately $500,000 for knowingly committing five violations of the Iranian sanctions regulations by purchasing a cement component from Iran. The aggregate value of the five transactions, according to OFAC, totaled some $14.5 million.
According to OFAC, one recurring problem in all three cases was that the companies lacked adequate internal compliance programs aimed at preventing violations of sanctions regulations. In fact, in the case of e.l.f. Cosmetics, it appears the company had failed to implement any sanctions-related compliance program at all. Internal compliance programs are of paramount importance to any business that operates overseas. As OFAC noted in announcing the fines assessed in the Connecticut case, “[t]his case demonstrates the importance for companies operating in high-risk industries (e.g., international trading) to implement risk-based compliance measures, especially when engaging in transactions involving exposure to jurisdictions or persons implicated by U.S. sanctions.” Best practice here is to integrate an OFAC program with an existing anti-bribery ethics program and any “know your customer” procedures designed to ensure clients and suppliers will be able to meet their contract obligations.
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